A quiet but significant shift is reshaping the ESG investment landscape. DWS, the €933 billion German asset manager behind the Xtrackers ETF range, has relaxed its weapons screening criteria across its fund suite, becoming the latest in a growing line of European managers to soften their exclusions on defence and weapons companies.
For GCC-based investors who use ESG-labelled ETFs or assume they are investing ethically through them, this demands attention. The commercial logic behind the shift is compelling. But for Gulf investors, the implications go further than portfolio composition: as regional defence budgets surpass $114 billion annually, ESG funds relaxing weapons screens are increasingly buying exposure to the very contractors supplying Gulf nations.
The credibility gap hiding in plain sight
A stark disconnect exists between what ESG funds promise and what they actually deliver. While 92% of Article 8 ESG funds claim weapons exclusions in their prospectus, only 31% actually apply them in their portfolios. Even more concerning, Article 8 funds have doubled their defence exposure since 2022, yet their prospectus language has not kept pace with what fund managers are actually holding.
Why Managers Are Loosening Screens
Fund managers are responding to intense performance pressure and institutional client demand rather than philosophical arguments. ESG large-cap European funds trailed conventional peers by approximately 3% in mid-2025, with defence underweighting as the primary driver. Meanwhile, Rheinmetall, Germany's largest arms manufacturer, previously excluded from most ESG portfolios, surged roughly 900% over three years and posted record operating profits of €1.84 billion in 2025.
The pivot is not purely philosophical. Rheinmetall saw revenues grow 29% year-on-year in 2025 to €9.9 billion, with retail trading in the stock ramping from €71 million in November 2024 to €500 million in November 2025, a sevenfold increase in twelve months. The share of active Article 8 funds with more than 5% defence allocation rose from just 3% in 2022 to 19% by June 2025.
Structural demand for defence exposure ensures this is not a temporary shift. NATO members are committed to raising defence spending to 3.5-5% of GDP by 2035, and the EU has earmarked up to €800 billion for its Readiness 2030 programme. Rheinmetall projects its own revenues will quintuple to roughly €50 billion by 2030. European defence ETF assets surged from $2.5 billion at the end of 2024 to over $7 billion by April 2025. With that growth in investor demand, fund managers face intense pressure to provide access.
For investors seeking non-European defence exposure, KDEF, the PLUS Korea Defence Industry ETF, tracks South Korean names including Hanwha Aerospace (18.65% weight), Hyundai Rotem (10.87%), and Korea Aerospace Industries (9.78%). Korean defence is emerging as a significant beneficiary of global rearmament demand.
Industry-Wide Policy Revisions: Confirmed Changes and Funds Under Review
GCC-Specific Risk: The Feedback Loop
For Gulf-based investors, this story carries a unique dimension that European investors do not face. Gulf nations are among the world's largest defence importers, with Qatar purchasing $47.9 billion in US arms since 2010 and Saudi Arabia ranking as the world's seventh-largest military spender globally. Combined, GCC defence spending exceeds $114 billion annually.
This creates a feedback loop specific to Gulf investors: as GCC defence spending rises, international defence contractors win supply contracts, their stocks surge and grow as a share of global indices, ESG funds with relaxed screens increase defence allocations, and GCC-based suppliers benefit from capital flows. Buying an ESG ETF today may mean indirectly financing the regional security infrastructure that your government is already funding through procurement.
Saudi Arabia's Vision 2030 targets 50% domestic military procurement by 2030, making this concern even more pressing. As domestic manufacturers like SAMI (Tadawul-listed) and EDGE Group (UAE) expand, they become eligible for ESG index inclusion now that conventional weapons screens have been removed at the index level.
GCC defence spending by country (2023, USD billions)
Risk Assessment for GCC Investors
Current ESG ETF holdings should be reviewed carefully in light of the recent policy changes. Some products carry higher defence exposure risk than others, while Sharia-compliant alternatives maintain stricter and more stable screening criteria.
For Tadawul investors specifically, the Yaqeen S&P ESG MENA ETF (9409) does not explicitly specify exclusion criteria for weapons and defence in its prospectus. Contact Yaqeen Capital to confirm the current defence revenue threshold, whether the screening methodology changed post-December 2025, and whether any GCC defence companies are currently held.
Bottom Line
In a world where ESG screens prove commercially malleable and subject to institutional pressure, Sharia-compliant funds offer exclusion criteria governed by religious scholarship rather than market conditions. For GCC investors concerned about the credibility of ESG screening and the unique feedback loop of defence spending in the Gulf, this distinction is now practically essential. The shift away from strict weapons exclusions in mainstream ESG funds makes Sharia-compliant alternatives increasingly attractive for those seeking predictable, principle-based screening.
