Geopolitical Risk and Strategic Asset Allocation: Defense and Cybersecurity as Hedges in a Fractured World

In an era of escalating geopolitical tensions—from Russia's war in Ukraine to China's assertive posturing in the Indo-Pacific—investors are recalibrating their portfolios to hedge against uncertainty. The defense and cybersecurity sectors have emerged as critical components of this reallocation, offering resilience amid volatility. According to a report by Morningstar, global defense spending surged to $2.7 trillion in 2024, a 9.4% real-term increase from 2023, with European nations leading a “supercycle” of military investment, projecting annual growth of 6.8% through 2035 Global Defense Sector: Investment Trends & Advisor Insights^[1]. Meanwhile, cybersecurity spending is on track to reach $298.5 billion by 2028, driven by AI-driven threats and supply chain vulnerabilities Geopolitical tensions, AI and more are complicating the …^[3].

Defense as a Strategic Hedge

Defense stocks have historically acted as defensive assets during geopolitical crises. A 2024 study analyzing 90 defense and cybersecurity companies found that 81.4% of defense firms were impacted by the Russia-Ukraine war, with stock prices reacting swiftly to geopolitical developments Investigating the effect of geopolitical risk on defense companies ...^[5]. For example, Kratos Defense & Security Solutions (KTOS) reported a 9.2% year-over-year revenue increase in Q1 2025, fueled by contracts for hypersonic systems and drones Global Defense Sector: Investment Trends & Advisor Insights^[1]. Similarly, Palantir Technologies (PLTR) saw government revenue rise 45% year-over-year, bolstered by a NATO contract Global Defense Sector: Investment Trends & Advisor Insights^[1].

The sector's resilience stems from its inelastic demand. Unlike cyclical industries, defense spending is politically driven and less sensitive to economic downturns. As BlackRock notes, defense beneficiaries often correlate positively with gold and the VIX volatility index during crises, making them attractive for diversification Defense Sector on the Radar - BlackRock^[2]. However, risks persist: customer concentration (e.g., reliance on government contracts) and policy shifts can create headwinds. Investors are advised to adopt active, selective strategies, favoring firms with diversified product lines and exposure to emerging technologies like AI and cyber-physical systems Global Defense Sector: Investment Trends & Advisor Insights^[1].

Historical backtesting of defense sector stocks that beat earnings expectations from 2022 to 2025 reveals divergent outcomes. For instance, Lockheed Martin (LMT) delivered a 20.9% cumulative return with a 6.5% maximum drawdown, while Northrop Grumman (NOC) declined by 8.4% despite similar earnings surprises. This underscores the importance of stock-specific dynamics and the need for a differentiated approach within the sector.

Cybersecurity: The Digital Frontline

Cybersecurity has become a non-discretionary priority for governments and corporations alike. The World Economic Forum's 2025 Global Cybersecurity Outlook highlights that 75% of organizations increased cybersecurity budgets in 2025, with 60% reshaping vendor strategies due to geopolitical tensions Geopolitical tensions, AI and more are complicating the …^[3]. CrowdStrike (CRWD) and Zscaler (ZS) exemplify the sector's growth, with CRWD's stock rising 37% year-to-date in 2025 and ZS up 33%, driven by cloud-native platforms and AI-powered threat detection Defense Sector on the Radar - BlackRock^[2].

The sector's appeal lies in its dual role as both a defensive and growth asset. Unlike traditional defense, cybersecurity is not confined to national borders; it addresses globalized threats such as AI-driven cybercrime and supply chain attacks. For instance, the EU's €2.0 billion annual allocation for cyber defense in 2025 underscores its strategic importance Geopolitical tensions, AI and more are complicating the …^[3]. Yet, the sector faces challenges, including rapid technological obsolescence and regulatory fragmentation. Investors must prioritize companies with recurring revenue models and strong R&D pipelines to navigate these risks Geopolitical tensions, AI and more are complicating the …^[3].

Strategic Asset Allocation Frameworks

Geopolitical risk has reshaped asset allocation models, with defense and cybersecurity increasingly viewed as complementary hedges. A 2024 study on geopolitical risk contagion found that defense and cybersecurity sectors exhibited lower volatility than energy and critical raw materials during crises, making them ideal for balancing portfolios Global Defense Sector: Investment Trends & Advisor Insights^[1]. For example, during the 2024 Israel-Hamas conflict, Israeli defense stocks outperformed global peers, while European firms remained insulated from localized shocks Investigating the effect of geopolitical risk on defense companies ...^[5].

Practical allocations might include:
- Defensive Exposure: 5–10% in defense ETFs (e.g., Xtrackers' CRTC, which screens out companies tied to high-risk nations) CRTC: Mitigate Portfolio Exposure to Growing Geopolitical Risks^[4].
- Growth Allocations: 3–5% in cybersecurity equities, favoring firms with cloud-first architectures and AI integration Defense Sector on the Radar - BlackRock^[2].
- Diversification: Pairing these sectors with gold (historically averaging 1.6% weekly returns during GPR spikes) and long-duration bonds to mitigate tail risks Geopolitical tensions, AI and more are complicating the …^[3].

Conclusion: Navigating a Fractured World

As geopolitical tensions persist, defense and cybersecurity will remain pivotal in strategic asset allocation. While these sectors offer resilience, their idiosyncratic risks demand careful management. Investors must balance long-term growth in high-tech defense systems with short-term hedging against volatility. The key lies in proactive risk monitoring, scenario planning, and leveraging sectoral interdependencies—such as AI's dual role in military and cyber applications—to build adaptive portfolios. In a world of cascading crises, the ability to anticipate and respond to geopolitical shifts will define investment success.