Defence ETFs Surge in 2026 on Geopolitical Tensions

Introduction: A Sector in the Spotlight

Global geopolitical instability and rising national security concerns have pushed the defence sector into the investment spotlight. As governments worldwide increase military spending, exchange-traded funds (ETFs) focused on aerospace and defence companies are delivering notable returns. This trend is prominent in both established markets like the United States and rapidly growing economies like India, where policy shifts are creating a robust domestic manufacturing ecosystem. For investors, these developments present a clear theme of resilience and growth, making defence ETFs a focal point for portfolio allocation in 2026.

Global Tensions Fuel US Defence Stock Outperformance

The direct correlation between geopolitical risk and defence sector performance is clearly illustrated by the iShares Aerospace & Defense ETF (ITA) in the United States. Through March 10, 2026, the ITA has generated a 12% return, starkly outperforming the S&P 500 index, which recorded a 0.9% loss over the same period. This divergence highlights a flight to safety and a strategic rotation into sectors with predictable, government-backed revenue streams.

Events such as the ongoing conflict in the Middle East have solidified a bullish outlook for the sector. The market anticipates sustained demand for military hardware, technology, and services, benefiting the large-cap US contractors that dominate the ITA's portfolio. This outperformance, if sustained, could mark one of the fund's best calendar years relative to the broader market on record.

Top Holdings and Valuation Concerns

The ITA provides concentrated exposure to the largest players in the industry. Seven of the world's ten largest publicly traded aerospace and defence firms are based in the US and are key holdings in the fund. Performance among these giants has been strong year-to-date:

• Lockheed Martin (LMT): +35%
• Northrop Grumman (NOC): +29%
• Howmet Aerospace (HWM): +24%
• RTX (RTX): +13%

However, this strong performance has pushed valuations to elevated levels. The ITA currently trades at 39 times its projected 12-month earnings, significantly above its 10-year average of 25. In comparison, the S&P 500 trades at a multiple of 21, only slightly above its 10-year average of 20. This premium suggests that while fundamentals are strong, much of the positive outlook may already be priced into these stocks.

The Indian Defence Sector's Structural Growth

Pivoting to Asia, India's defence sector is undergoing a structural transformation driven by the government's 'Atmanirbhar Bharat' (self-reliant India) initiative. This policy aims to boost domestic manufacturing and reduce reliance on imports. The commitment is backed by significant financial allocation, with the defence budget for FY2026 increased by 9.5% to ₹6.8 lakh crore.

This strategic push is yielding tangible results. Private defence firms in India are projected to grow revenues by 16-18% in FY26, supported by a substantial order book. Furthermore, defence exports reached a record ₹21,083 crore in FY24, a 32.5% year-on-year increase, signaling India's growing presence as a global supplier.

A Look at India's Defence ETFs and Funds

To capitalize on this domestic growth story, several defence-focused ETFs and mutual funds have been launched in India, offering investors a straightforward way to gain exposure to the sector. These funds track indices like the Nifty India Defence Index and the BSE India Defence Index.

These funds primarily hold shares in leading public sector undertakings (PSUs) and private companies integral to India's defence ecosystem, including Hindustan Aeronautics Limited (HAL), Bharat Electronics Limited (BEL), and Mazagon Dock Shipbuilders.

Investment Rationale and Associated Risks

The primary appeal of defence ETFs lies in their direct exposure to a sector with long-term, government-backed contracts and a clear growth trajectory. In times of market uncertainty, the non-cyclical nature of defence spending can provide a valuable portfolio hedge. The sector benefits from multi-year procurement cycles, creating visible and stable revenue streams that are less susceptible to economic downturns.

However, investors must consider the inherent risks. As seen with the US-based ITA, strong performance can lead to high valuations that may not be sustainable. The sector is also highly dependent on government policy and budget allocations, which can change with political shifts. Furthermore, as thematic funds, they carry concentration risk, meaning any adverse development in the defence industry could significantly impact the fund's performance.

Conclusion

Defence ETFs have emerged as a compelling investment theme in 2026, driven by a confluence of geopolitical tensions and strategic government policies in key markets like the US and India. They offer a liquid and diversified vehicle to participate in the long-term growth of the aerospace and defence industry. While the outlook remains positive, investors should approach the sector with an awareness of the premium valuations and policy-related risks. A balanced perspective is essential to effectively integrate this high-potential theme into a diversified investment strategy.