Morgan Stanley Research / Sustainability: Aerospace & Defense: ‘No-Fly Zone’ for ESG?

22 Jul 2021 | Mark Carlucci CFA | Kristine T Liwag | Matthew Sharpe | Allison Binns Ph.D. | Andrew Humphrey | Jessica Alsford CFA | Victoria Irving | Jonathan Walker | Lucy Beauvallet | Tim Chan CFA
Sustainability: Aerospace & Defense: ‘No-Fly Zone’ for ESG?
Exclusion of Aerospace & Defense is prevalent among sustainability funds. While we expect that dynamic to persist, we also see a possible role for the sector as “mainstream” investors integrate ESG. We outline factors that could shape investment approaches.

Considerations for A&D in a sustainable investing framework. A&D represents an overwhelmingly unowned sector among funds with dedicated sustainability strategies. However, sustainable investing is a spectrum with a large and growing cohort of “mainstream” investors integrating ESG — a lens within a broader investment framework. We believe A&D equities might, in some instances, fit within the less defined integration strategies, the focus of this report. As ESG integration evolves, we recognize asset owners will likely influence investment approaches among asset managers, similar to prior divestments of fossil fuel exposure. We also appreciate that perceptions among asset owners might vary — a debate that could drive multiple approaches, especially in the US relative to Europe. In this report, we explore exclusionary and thematic considerations that could shape mainstream integration strategies.

Decarbonization and cyber: constructive ESG themes. Aviation represents a hard to decarbonize industry, and potential solutions include sustainable aviation fuels, electric & hydrogen power, and turbine changes, among other efficiencies. Key stocks with potential enabling roles across these pathways include Boeing, Airbus, Safran, Rolls-Royce, MTU Aero Engines, and Raytheon Technologies. Separately, recent cyber attacks on key infrastructure assets have elevated risks of broad disruption to society. Cyber strategies across A&D vary by level of disclosure and type, with offensive and/or defensive characteristics. Stocks with notable cyber programs include Northrop Grumman, BAE Systems, Thales, and Raytheon Technologies.

Could US investors adopt a different view on Defense? Asset owners in the US, which occupies a unique position against the global Defense backdrop, may perceive the industry differently than their peers in Europe. We see a potential debate forming around the sector’s role in contributing to political stability and conflict prevention on a global scale, with potential implications for how investors in the US might approach ESG integration for the industry.

Integrating ESG into risk-reward. Building on integration of ESG into published research since 2012, we now integrate ESG into Morgan Stanley’s Risk Reward platform. Within our global A&D franchise, we rolled out ESG Risk Reward integration earlier this year in Europe. With this report, we expand the rollout to A&D in North America.