The Case for Diversification in Defense Investing

Investing in the defense sector carries specific risks. Company revenues depend heavily on government budgets, which can be cut, delayed or redirected as political priorities change, and contracts are often concentrated among a small number of national customers. Stocks can react sharply to geopolitical events — both escalation and peace talks — as well as to export restrictions, sanctions and changes in procurement policy. And newer areas such as drones, AI and space are still evolving, so today’s winners may not stay ahead. A sector-focused ETF concentrates these risks, and its value may fall as well as rise. You may lose money up to the total loss of your investment due to the Main Risk Factors such as Equity Market Risk, Liquidity Risks and Industry or Sector Concentration Risk described in the KID and in the sales prospectus. Market evolution not guaranteed.

References to specific companies or securities in this communication are for illustrative purposes only, to describe market and industry trends, and do not constitute investment research, advice, or a recommendation to buy, hold or sell any security.

When the United States and Israel launched strikes on Iran on 28 February 2026¹, defense stocks initially rallied. After a day or so, though, they fell back on fears that conflict would spread across the Middle East sparking higher oil prices.

In the weeks that followed the fall continued. During March, the US Defense stocks fell almost -8% in US dollars, while the European stocks in the VanEck Defense UCITS ETF (DFNS) fell -11%. Meanwhile, the whole of the globally diversified DFNS declined a relatively small -6.3%.

Despite 2026’s disappointing performance, the long-term global theme of rising defense spending lifting the sector remains intact. Notably, the White House’s Budget of the U.S. Government, Fiscal Year 2027 requests $1.5 trillion for national defense, a 44% increase on the 2026 level, subject to Congressional approval². NATO’s target, set out in the Hague Summit Declaration of June 2025, of raising spending to 5% of GDP by 2035 signals the end of the past-Cold War ‘peace dividend’³. And the European Commission’s ReArm Europe Plan/Readiness 2030 aims to mobilize up to EUR 800 billion for defense⁴.

Yet reinforcing the merits of investing through a globally diversified portfolio, short-term movements in stocks, and differences between regional performances, are hard to predict. They increasingly respond to the same kind of fundamental news as all stocks in defense-related sectors — orders, deliveries and earnings — as well as national defense policy shifts.

Rotating Regional Leadership

Regional leadership has rotated from year to year, influenced to a degree by policy changes that impact stock prices. So far in 2026, Asia-Pacific and Israeli defense stocks have led the way, as they did in 2025. European stocks were the runners up in both 2026 and 2025, with strong gains in 2025 due to the continent’s rearmament boom. US defense stocks experienced their moment in the sun during 2024, when they led the pack.

Across these three years, VanEck’s diversified DFNS ETF steered a middle course — smoothing out regional performance differences (see chart below). In 2026 to September-end, it’s down -4.4%, trailing the gains in Asia-Pacific and Israel but cushioning the losses among US stocks. The overall ETF has lost slightly more than its European holdings, but not much.

Regional Returns by Calendar Year

*2023 runs from the fund’s launch on March 31, 2023. Source: VanEck. YTD figures as of 30 September 2026 in USD. The ETF’s inception date is 31 March 2023. Past performance does not predict future returns. Performance quoted represents past performance. Current performance may be lower or higher than average annual returns shown. Performance data for the Irish domiciled ETFs is displayed on a Net Asset Value basis, in Base Currency terms, with net income reinvested, net of fees. Returns may increase or decrease as a result of currency fluctuations. Performance should be assessed over a medium- to long-term.

From Prime Predictability to Drone Dynamism

For further evidence of the value of diversification, look to the wide performance gap between the large defense majors, or primes, and the mid-sized and smaller companies on the cutting edge of warfare. While the former makes traditional hardware like tanks, missiles, ships and electronics that remain an essential part of armed forces, the latter pioneer the latest drone equipment and AI software.

Once again, there’s no consistency as to what leads the sector from one year to the next. To make a valid comparison, it’s necessary to strip out Palantir, the big US defense technology and data company, as its stellar stock returns distort the picture. Having done so, the mid and small capitalization stocks in DFNS led returns in 2024, but the large cap holdings have outperformed since (see chart below). What’s certainly true is that DFNS’s strategy of diversifying across the size range has resulted in a stronger risk-return profile — or return per unit of risk (see return / volatility column, 1.7 result) — than relying on any size group in isolation.

Risk and Return Over Three Years

Source: VanEck. YTD figures as of 30 September 2026 in USD. The ETF’s inception date is 31 March 2023. Past performance does not predict future returns. Performance quoted represents past performance. Current performance may be lower or higher than average annual returns shown. Performance data for the Irish domiciled ETFs is displayed on a Net Asset Value basis, in Base Currency terms, with net income reinvested, net of fees. Returns may increase or decrease as a result of currency fluctuations. Performance should be assessed over a medium- to long-term.

Backing the Global Trend

There’s a fundamental logic to defense diversification. The large defense majors, many based in the US, have multi-year order backlogs that give earnings visibility. In 2026, they were the only size group with a positive return. By contrast, smaller and mid-sized stocks offer exposure where defense is changing: drones, space-based surveillance, AI and counter-drone systems.

As geopolitical tensions remain high, so too does the upward trend in military spending. Yet short-term moves like the reaction to the outbreak of the Iran War are harder to predict, as are regional moves that depend so much on policy and geopolitics. Just as few observers expected the strikes on Iran, when might peace come to Ukraine and how would that affect Europe’s defense stocks?

For investors seeking to back the rising trend in military spending, the overall trend is clear but the variations within are harder to judge. Diversification offers one way to manage that uncertainty.

VanEck Defense UCITS ETF (DFNS) Performance (%)

Trailing returns as of 30 September 2026

Calendar-year returns

Source: VanEck. YTD figures as of 30 September 2026 in USD. The ETF’s inception date is 31 March 2023. Past performance does not predict future returns. Performance quoted represents past performance. Current performance may be lower or higher than average annual returns shown. Performance data for the Irish domiciled ETFs is displayed on a Net Asset Value basis, in Base Currency terms, with net income reinvested, net of fees. Returns may increase or decrease as a result of currency fluctuations. Performance should be assessed over a medium- to long-term.

Additional Glossary

Max drawdown: the largest peak-to-trough decline in the fund’s value over the period shown.

Annualized: figures restated as an equivalent annual rate to allow comparison across different time periods.

Return/volatility ratio: the fund’s return divided by its volatility (a measure of price fluctuation), indicating how much return is generated per unit of risk taken.