(Bloomberg) -- An ESG fund run by Alken Asset Management Ltd. has outperformed 98% of its peers over the past year after betting on European defense stocks while they were still cheap.
The Alken Fund Sustainable Europe (ALCSEU1 LX) is up about 9% in the period, compared with an average drop of roughly 9% among similar funds, according to data compiled by Bloomberg.
London-based Alken, which oversees about 1.5 billion euros ($1.5 billion) in total, is the latest example of an investment manager offering outsized ESG returns by betting on industries that aren’t generally associated with environmental, social or governance goals. Alken’s Sustainable Europe fund, which is registered in Luxembourg, qualifies as a so-called Article 8 product under European ESG rules, meaning it “promotes” sustainability.
After years of under-investment, Europe’s defense sector was undervalued and poised to “benefit massively” from the current political climate, Nicolas Walewski, founder of Alken Asset Management and co-manager of the firm’s Sustainable Europe fund, said in an interview.
Alken started buying defense assets in the middle of last year, Walewski said. He and his team were “surprised” that others weren’t doing the same, but more investors then “actually jumped in fairly quickly in March and April,” he said. Aside from defense stocks such as Thales SA, the portfolio is overweight industrials in general as well as energy companies, including some fossil-fuel producers, Walewski said.
Ukraine
When it comes to ESG bets, defense stocks are about as controversial as it gets. The weapons industry has this year embarked on an intense lobbying campaign urging European lawmakers to label such assets as sustainable, and points to the West’s race to arm Ukraine to underpin its case.
But ESG purists argue that treating tools ultimately designed to kill as sustainable assets would be a slap in the face of everything that ESG is supposed to stand for. And with the arms industry “responsible for millions of deaths,” ESG data cruncher Util has characterized the whole idea as misguided.
Walewski said it’s wrong to rule out weapons as sustainable assets in the current geopolitical climate, in which authoritarian regimes are growing increasingly belligerent toward Western democracies and their allies.
“We have to defend our countries,” he said. “You don’t defend your countries with flowers.”
Investors that bought European defense stocks well before the war in Ukraine have enjoyed considerable gains over the past year. Rheinmetall AG, one of Germany’s biggest arms manufacturers, is up almost 120% this year alone as Chancellor Olaf Scholz recasts his country’s post-World War II policy with an historic arms spending spree. French defense company Thales has gained more than 60%.
There’s been a “wake-up call,” Walewski said. Although the fund has in the meantime trimmed its exposure to defense somewhat, Walewski said he expects the sector to remain attractive. “Of course they’re not going to outperform by 100% every six months, but we still think the long-term future is bright.”
“It will take years for these companies to keep up with the demand,” he said. “The world is unsafe.”
Goldman Sachs’ basket of European stocks with exposure to defense spending, which includes Rheinmetall, Thales and BAE Systems Plc, is up 58% this year, compared with a 13% decline for the benchmark Stoxx Europe 600 Index. Meanwhile, sectors that have traditionally been ESG darlings -- such as tech -- have slumped in 2022, with the MSCI World Information Technology Index down about 23%.
“Defense is good. It’s very sustainable,” Walewski said. “We’ve just rediscovered that.”
The Sustainable Europe fund that Walewski co-manages revamped its investment approach a few years ago and now pays much closer attention to any warning signs that a company might be hit by potential governance issues. That’s after being burned by its stake in German electronic payments provider Wirecard AG, which collapsed in 2020 after becoming embroiled in an accounting fraud scandal. The company made up around 10% of Alken’s Sustainable Europe fund at one point. The asset manager has sued Wirecard.
Fossil Fuels
The fund’s embrace of energy stocks has also been a driver of returns, with the sector being the best performing subgroup in the Stoxx Europe 600 Index this year. Alken targets companies that invest a “significant part” of their capital spending on the energy transition.
“That’s the best way to be a sustainable fund,” Walewski said. He also sees hydrocarbons as an essential part of the world’s power supply for decades to come. “It’s unsustainable not to allow us to satisfy 80% of our energy needs for at least the next 10, 15 years.”
“We cannot increase the speed of renewables in the global energy mix that much,” Walewski said. “It will remain a moderate part of the global energy mix for a very long time. Not 2, 3 years -- a very long time. 20, 30 years at least.”
©2022 Bloomberg L.P.
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