Defense: Why Operational Systems Are Transforming Investment for the French

Long perceived as a bastion of heavy armaments manufacturing, the defense sector is undergoing a major transformation. A recent analysis by Bloomberg, highlighted by Meghan Welch, Managing Director at Brown Gibbons Lang & Co., reveals a fundamental shift: investment is now focusing on systems that ensure military preparedness and operational capability on a daily basis. It’s no longer just about producing tanks or planes, but about ensuring their functionality, security, and constant adaptation to modern threats. This strategic pivot, driven by critical tailwinds, is attracting significant public and private interest and funding, reshaping the landscape for investors.

New Frontier in Defense Investment: Operational Systems

The key point lies in the reallocation of capital toward so-called "operational systems." Concretely, this encompasses a wide range of technologies and services essential to modernizing armed forces. This includes command, control, communications, computers, intelligence, surveillance, and reconnaissance (C4ISR) systems, cutting-edge logistics, predictive maintenance, training simulators, cybersecurity for military networks, or AI-based intelligence and data analysis capabilities. These elements are the invisible yet indispensable gears that ensure the efficiency and responsiveness of modern armies.

Meghan Welch explicitly highlighted on Bloomberg Surveillance that "the next phase of defense sector investment is increasingly focused on systems that maintain military preparedness and operational capability on a daily basis, rather than just weapons." This statement underscores a growing awareness: owning cutting-edge equipment is no longer sufficient; it must be constantly operational, interconnected, and protected against increasingly sophisticated threats. The budgets allocated to these systems are often recurring and less subject to major political procurement cycles, potentially offering greater stability.

This evolution is all the more significant as it touches on the very essence of modern military power. The effectiveness of an army is no longer measured solely by the quantity of its equipment but by its ability to coordinate, maintain, protect its information, and anticipate enemy movements through advanced analytical tools. It’s a constant race for innovation where technological superiority in systems is now a decisive factor.

Drivers of a Profound Transformation of the Markets

Several factors converge to explain this growing enthusiasm for operational systems. First, the global geopolitical context, marked by persistent conflicts and heightened tensions, has led many countries to reassess their defense budgets. The invasion of Ukraine, for example, has underscored the crucial importance of resilience and operational efficiency of armed forces. NATO member countries are increasingly committing to reaching the goal of spending 2% of their GDP on defense, with a focus on modernization and interoperability.

Second, the acceleration of technological progress plays a pivotal role. Modern warfare is increasingly a war of information, cybernetics, and artificial intelligence. Operational systems are at the heart of this transformation, enabling better data collection, faster analysis, and more informed decision-making. Needs in cybersecurity, resilient satellite communication, and advanced sensors have become priorities. These segments offer significant growth potential and long-term development prospects.

Finally, from an economic standpoint, investing in operational systems presents distinct advantages. Unlike major weapons programs, which are often decades-long projects with long and sometimes unpredictable procurement cycles, contracts related to operational systems can generate more recurring and stable revenues. These include maintenance services, software updates, continuous training, or technical support, which are essential over the lifespan of equipment. These more predictable revenue streams are particularly attractive to investors seeking stability within a sector traditionally perceived as cyclical.

Concrete Impact for the French Investor

For the French investor, this evolution in the defense sector opens up interesting perspectives, accessible through various investment vehicles.

Investing Through a PEA (Individual Savings Account)

The PEA is a preferred investment vehicle for French tax residents, offering tax exemption on capital gains after five years of holding. Several major French and European companies are key players in operational systems and are eligible for a PEA:

• Thales: This French giant is a global leader in secure information and communication systems, cybersecurity, avionics systems, sensors, and mission systems. Its activities are directly aligned with the trend toward operational systems.
• Safran: Well-known for its aircraft engines, Safran is also a key player in avionics systems, navigation systems, and safety equipment for aerospace and defense, contributing to the modernization of operational capabilities.
• Dassault Aviation: Beyond its famous Rafale fighter jets and Falcon business aircraft, the company integrates complex mission systems, electronic warfare technologies, and connectivity solutions that are at the core of advanced operational systems.
• Airbus: Its Defense & Space division is a key player in communication and observation satellites, intelligence systems, and cybersecurity solutions, all essential for modern operational superiority.

Investing in these companies through a PEA allows you to benefit from their expertise in operational systems while optimizing your long-term tax efficiency. It’s crucial to diversify your portfolio and avoid concentrating investments in any single sector, even if it is promising.

Gaining Exposure Through a CTO (Ordinary Shareholder Account) and Life Insurance

For broader exposure or access to non-PEA eligible companies (notably American ones), a CTO or life insurance in unit-linked policies are relevant solutions. The ETFs sector-specific:

• Defense & Aerospace ETFs: There are specialized ETFs that combine a basket of stocks from defense and aerospace companies. The offering is richer in the United States (e.g., iShares U.S. Aerospace & Defense ETF - ITA, or SPDR S&P Aerospace & Defense ETF - XAR), but broader European funds may also include relevant companies. It’s important to verify the composition of the ETF to ensure it aligns well with the angle of operational systems.
• Technology or Industrial ETFs: Some more generalist ETFs, focused on innovation or industry, may include companies heavily involved in operational systems, even if that’s not their primary focus.

The advantage of a CTO is its flexibility, allowing investments in global stocks. However, capital gains are subject to the 30% flat tax for French residents. Life insurance offers a favorable tax framework after 8 years and allows investment in unit-linked accounts (including ETFs), offering diversified exposure.

Perspectives and Risks to Consider

The shift toward operational systems is giving the defense sector a new dynamic. While the sector was traditionally seen as cyclical and dependent on major state orders, the focus on services, maintenance, and system updates could make it more resilient and less volatile. The need for constant innovation, particularly in artificial intelligence, quantum computing, and cybersecurity, ensures ongoing investment in research and development. This can create opportunities for specialized companies and potentially M&A operations.

However, investing in the defense sector is not without risks. Fluctuations in government budgets, changes in defense policy, and geopolitical risks remain significant factors. Additionally, for some investors, ethical and environmental considerations (ESG) related to the arms industry may pose questions. It’s essential to align investments with your own values and risk tolerance. As with any investment, thorough analysis and adequate diversification are crucial.

Legal Disclaimer: The information contained in this article is provided for illustrative and educational purposes only and does not constitute personalized investment advice. Stock market investing carries risks of capital loss. Before making any investment decision, it is recommended to consult a professional financial advisor and conduct your own due diligence. Past performance is not indicative of future results.