If you have any ethical hang-ups about owning defence companies, stop reading now. It’s completely fair to not feel comfortable owning shares in a company that manufactures weapons, especially when those may be used in ways that result in deaths.
But for those of you without those concerns, it’s worth noting that Canada doesn’t really have a defence industry to invest in. If you’re looking for exposure, you’ll need to look south to the U.S., or even internationally to Europe.
Right now, there’s only one exchange-traded fund (ETF) on the TSX that offers pure-play defence industry exposure. Here’s why I’d buy it instead of picking individual stocks for a $7,000 investment.
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Why use an ETF for defence stocks?
Unlike sectors like consumer staples, where a few diversified giants dominate and owning two or three stocks can give you solid exposure, the defence sector is a lot more fragmented and competitive. There’s no one-size-fits-all company that covers the entire landscape.
Defence is made up of multiple sub-industries: aerospace, ground systems, naval systems, intelligence, detection and surveillance, cybersecurity, missile systems, and now, newer areas like drones and autonomous platforms. No single company does it all — so unless you’re buying an ETF, there’s no simple way to cover the whole space.
The other challenge is how defence companies make money. Especially in the U.S., many of the large firms rely on massive, multi-year contracts awarded by the Department of Defense. These contracts often total millions — or even billions — of dollars and typically go to a single winner known as the “prime contractor.” That means multiple large companies might all be bidding for the same deal, but only one walks away with the win.
So when a contract gets awarded, the share price of the winner can jump, while the others can take a hit. Unless you have the time and experience to research these businesses in depth, investing in defence stocks can feel like flipping a coin.
That’s why I prefer using a defence-focused ETF. It lets you bet on the broader trend of a more unstable world and rising military spending — without trying to guess which company lands the next big contract.
The only TSX defence ETF you can buy (for now)
If you’re a Canadian investor looking for defence exposure in Canadian dollars, your only current option is the iShares U.S. Aerospace & Defense Index ETF (TSX:XAD).
XAD tracks 36 companies included in the Dow Jones U.S. Select Aerospace & Defense Index. Just be warned — this is not a diversified ETF. It’s a narrow, single-industry fund, and the top two holdings make up roughly 35% of the portfolio.
There’s also some risk that XAD could shut down if it doesn’t attract more investor interest. As of now, it only has about $30 million in assets under management. For long-term viability, ETFs usually need to cross the $50 million threshold.
That said, the performance backdrop is promising. XAD itself launched on September 6, 2023, but its U.S.-listed counterpart has a longer track record and has returned an annualized 10.6% over the past 10 years.
On fees, XAD charges a 0.44% management expense ratio, which is higher than what you’d pay for a broad market ETF, but actually quite reasonable for a sector-specific fund.
Bottom line: if you want to invest in defence stocks as a Canadian, XAD is your best — and only — TSX-listed option for now. Just be mindful of the risks and consider limiting your allocation to no more than 20% of your total portfolio.
