The rise of the drones

There were many eye-catching elements in China’s Victory Day Parade in Beijing on 3 September, not least the sight of Russian president Vladimir Putin and North Korea’s Kim Jong-un flanking Xi Jinping as the Chinese premier showcased his country’s military might, including a futuristic arsenal of laser weapons, nuclear missiles and some of the latest advances in drone and defence technology.

These technologies covered land, air and sea: “robotic wolves” – four-legged robots that can provide reconnaissance, carry ammunition and even launch precision strikes; AI-powered aerial drones that can fly alongside manned fighter jets; and perhaps most impressively the AJX-002, a 60-foot, unmanned submarine that can operate up to 20 metres underwater.

Drone technology is changing the face of warfare and accelerating a large shift in military doctrine, says Noah Ramos, a strategist at Alpine Macro. Drones that operate on land, sea and air are increasingly capable of interacting and collaborating with other drones, as well as with their human operators. This is shifting the balance of power within conflicts. Ukraine’s survival against all the odds following Russia’s invasion in February 2022 has been, in large part, thanks to its harnessing of drone technology. Its military, seemingly hopelessly undermanned and under-financed compared with Russia’s, has managed largely to neutralise Russia’s sophisticated (and expensive) war machines with a massive fleet of relatively inexpensive drones, two-fifths of which are made in Ukraine. Oleksandr Kamyshin, president Volodymyr Zelensky’s adviser for strategic affairs, told Bloomberg in July that weapons production is “Ukraine’s oil” and that the country is “rethinking warfare”.

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What we have seen in the Ukraine war is that air defence can only work at scale if there is “drone parity”, Loredana Muharremi, aerospace and defence equity analyst at Morningstar, told MoneyWeek. Ukraine shows that “drone innovation is fast, cheap, but also decisive in overpowering more traditional, complex, expensive and slow systems”. The goal of drone manufacturers is not necessarily to create the “best” drone, but the most adaptable and cost-effective. The goal is to innovate quickly, produce cheaply and deploy quickly, she says. Companies that can do that “can enjoy, we believe, lasting competitive advantages”.

Trends in drone technology

On the same day that Xi Jinping flexed China’s military muscles before the eyes of the world, Peter Fortune, the MP for Bromley and Biggin Hill, told a House of Commons debate on the role of drones in warfare that “a $300,000 sea drone can destroy fighter jets worth $50bn”. Alistair Carns, the minister for the armed forces, told the same debate that countries such as Russia and China are already producing drones on an industrial scale and investing in innovation to make them more capable and deadly, and to remove the human presence even further from the battlefield. “War,” he said, “is driving an innovation cycle that cannot be replicated in peacetime.”

Carns has previously described recent advances in drone technology as “a machine-gun moment for the army, a submarine moment for the navy and a jet-engine moment for the air force”. But drones are not as new as one might imagine. Unmanned aerial vehicles were tested for training purposes by the British military during the World War I and the UK produced a number of unmanned aircraft in the 1930s.

One of these, the DH.82B Queen Bee, is thought to have inspired the term “drone”. Reconnaissance drones were also widely deployed during the Vietnam War and they have been used in various military contexts since, including acting as decoys, dropping leaflets and as weapons. Carns made the point to Parliament that drones can use thermal imaging to locate casualties who are hidden in rubble, smoke or woodland, and can deliver medical supplies to inaccessible areas, sheltering human medics from danger in doing so.

There are, in short, drones for just about everything on the battlefield these days. They can provide a mass of platforms that confuse the defence systems of the enemy, says Muharremi, and are cheap and hence expendable. They can overwhelm enemy radars and electronic warfare defences.

From the pages of science fiction

At the other end of the spectrum, some advanced drone variants are seemingly taken straight from the pages of science fiction. As impressive as China’s Victory Day display was, the country is largely playing catch-up to the US, which remains the world’s leader in drone technology. The Manta Ray, produced by the from US Defence Advanced Research Projects Agency (Darpa) and Northrop Grumman, is a case in point: it is a long-distance underwater drone that can harvest energy from ocean thermal gradients, as well as putting itself into a low-energy “hibernation” mode if required.

“Think of this as essentially a surveillance vehicle that has no range limitations and is equipped with an entire suite of incredibly high-tech sensors,” says Ramos. Also, because it doesn’t emit “heat signatures”, its very hard for enemy systems to detect.

In many respects, the latest trends in drone technology mirror developments that are playing out in the civilian realm. Questions of automation, computer vision and energy storage are as central to modern drone design as they are to the self-driving car contest between Tesla and Alphabet’s Waymo. Modern drones, explains Ramos, will often have light detection and ranging (LiDAR) sensors stacked on top of hyperspectral sensors, giving them a 3D vision of where they’re going, making them more effective in “contested environments”.

Modern drones also make use of multiple power sources to minimise the risk of a single point of failure. This could take the form of a conventional fossil-fuel-based power source alongside a battery. “If one part goes down or is disabled electronically, through jamming, the system on board can continue to operate,” explains Ramos.

But artificial intelligence and automation are the most significant drivers of technological advancement. Drones have always been “unmanned”, but for most of their history this has meant that they are controlled remotely by a human operator. Just as civilian vehicles are becoming capable of driving themselves, military drones are increasingly autonomous. The autonomous unmanned aerial vehicle (UAV) is the “next generation” drone, says Ramos. “Swarms” of drones can already be operated by a single human operator as remote sensors automatically optimise the space between and the distribution of the drones members and adjust if, for example, some of the other drones within the swarm are destroyed.

Unlocking defence spending

Rapidly accelerating innovation in drone technology is converging with another key tailwind for the sector: increased defence spending by governments the world over. In Europe, in particular, the war in Ukraine and US president Donald Trump’s insistence that the continent contributes more towards its own defence, have concentrated minds and unlocked billions of euros in fresh spending commitments.

Similar dynamics are playing out in other regions, too. Following China’s military parade, exchange-traded fund platform HANetf analysed projected defence spending throughout the Indo-Pacific region. It estimated that there will be about $600bn in additional defence spending by 2030, with $44bn of this coming from mature economies such as Japan, South Korea, Australia, Singapore and Taiwan, and $144bn from fast-growing economies such as India, Indonesia and the Philippines. Last year, analysis from GlobalX, another ETF platform, predicted that global military spending on drones will have doubled to approximately $45.2bn by 2030.

“There is something of a race going on for these future defence technologies and that’s going to create a lot of spending across the board,” says Jane Edmondson, head of index product strategy at VettaFi. VettaFi is an index provider that compiles, among others, the EQM Future of Defence index.

How to invest

There are ethical considerations to keep in mind before investing in drones, as with any branch of defence technology. Complex issues are raised, but investors may like at least to ensure that the companies they are investing in are aligned with Western values. The HANetf Future of Defence ETF (LSE:NATP) tracks VettaFi’s EQM Future of Defence index, and as such all holdings are screened for their alignment with Nato member states or allies. Similarly, the Global X Defence Tech ETF (LSE:ARMG) filters out companies based in China, India, Kuwait, Pakistan, Russia and Saudi Arabia (as well as any countries that are categorised neither as developed nor as an emerging market).

Funds like these will give investors exposure to many of the largest and more technologically innovative defence companies, which are typically the ones at the front line of drone innovation. Many of these larger companies, such as Leonardo (Milan: LDO), Thales (Paris: HO) and Rheinmetall (Frankfurt: RHM), have entered the drone sector through bolt-on acquisitions: “Speed is important right now, so buying the companies that already have the capability to build drones is the fastest way to get into the market” for these businesses, says Muharemmi.

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