6 Equity Mutual Funds to Benefit from India’s Defence Sector

Apr 17, 2024 / Reading Time: Approx. 18 mins

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6 Equity Mutual Funds to Benefit from India’s Defence Sector

For a nation to walk on the path to progress and security of the people, defence plays an important role. In recent years, particularly after Russia's invasion of Ukraine, U.S.-China strained relations, so between North Korea and South Korea, India-China, and the crisis hit Pakistan, the geopolitical risk has heightened.

As per the global BlackRock Geopolitical Risk Indicator (BGRI), medium-to-high risks emanate from potential major cyber-attacks, terror attacks, tensions in the Gulf region, U.S.-China strategic competition, and Russia-NATO conflict. Even international rating agency S&P Global has highlighted these among the top 10 geopolitical risks of 2023.

Graph 1: Geopolitical Risk Indicator

(Sources: Federal Reserve Bank of New York; BlackRock Investment Institute, February 2024; and Bloomberg, as per RBI's March 2024 Bulletin)
 

Keeping a tab on the dynamic geopolitical environment, India over the last few years under the Modi-led-NDA government has made sizeable investments in the defence sector.

According to Stockholm International Peace Research Institute (SIPRI), India ranks third in defence expenditure after China and the U.S. In the Union Budget 2023, the government allocated Rs 5.95 trillion, an increase of 13% from the previous union budget. There is a clear thrust on the modernisation of India's defence capabilities.

In the previous fiscal year, i.e., 2022-23, India's defence production or turnover crossed over Rs 1 trillion for the first time ever (touched Rs 1.06 trillion), a rise of more than 12% over FY 2021-22 as per the Press Release of the Ministry of Defence. And if private firms engaged in defence industries are added, this figure is expected to be more. The number of defence licenses issued to industries in the last 7-8 years by the government have increased by almost 200%, according to the Ministry of Defence with emphasis on 'Make in India' and Aatmanirbharta (self-reliance) in defence. The Prime Minister, Narendra Modi has often stated that government will keep supporting efforts to make India a defence production hub.

The production target set by the government for India's defence sector is Rs 1.75 trillion (around USD 22 billion) by 2025. Out of that, exports would also play a pivotal role for players in the defence sectors. Last year, India's defence exports reached an all-time high of Rs 16,000 crore, which is 10x since 2016-17. Particularly over the last 5-6 years, the government has taken several policy initiatives and brought reforms to give a push to India's defence exports. From being an importer of various types of defence items eight years ago, today exports major platforms like Dornier-228, 155 mm Advanced Towed Artillery Guns (ATAGs), Brahmos Missiles, Akash Missile System, Radars, Simulators, Mine Protected Vehicles, Armoured Vehicles, PINAKA Rockets & Launchers, Ammunitions, Thermal Imagers, Body Armours, besides Systems, Line Replaceable Units and Parts & components of Avionics, and Small Arms. Plus, there is a growing demand for LCA-Tejas, Light Combat Helicopters, Aircraft Carrier, MRO activities etc. The government has set a target of USD 5 billion in defence exports by 2025.

[Read: Do General Elections Matter for the Indian Equity Markets]

Recently Iran-Israel has engaged in a military conflict, and there could be potential build-up of this in other regions of the Middle East, such as Iran, Lebanon, Iraq, Yemen, and Syria. Plus, escalations in the attacks in the Red Sea, may go on to disrupt trade and supply chains, lead to a rise in commodity prices, impact the disinflation process, and amplify the volatility in the financial markets.

Tensions are also brewing in the Korean peninsula, China is exhibiting its military prowess in the South China Sea to provoke Taiwan and the U.S., there are China-India scruffles at the border, the ongoing Russia-Ukraine war, and more.

Even while the Israel-Hamas conflict is a depressing reality for the people in the region, it offers India's defence exports a lucrative growth opportunity. Given that Israel is expected to approach its allies—the US, India, and others—to ensure enough supplies to fight the war, the escalation of this conflict could present opportunities for India's military companies in the near to medium term.

Given the above, the potential to benefit by sensibly taking exposure to defence sector stocks is huge!

Graph 2: Nifty India Defence Index - TRI vs. Nifty 50 - TRI

Base = Rs 10,000
Data as of April 16, 2024
Past performance is not an indicator of future returns.(Source: ACE MF, data collated by PersonalFN Research)
 

With which much progress made by India's defence sector in the last 5 years, the Nifty India Defence Index - TRI (which tracks the performance of listed defence companies) has delivered substantial returns -- outperforming the Nifty 50 -TRI and creating wealth for investors. Companies that have been the beneficiaries of India's thriving defence sector, especially the missile programme and aerospace sector, plus those in naval/marine capabilities, have done exceptionally well.

Table 1: Top-10 defence companies that all equity mutual funds have exposure to

Company Name Mutual Fund Holding - Mkt Value (Rs in Cr) as of 31st March 2024# Price as of 14th April 2024 Price as of 14th April 2023 % Change in Price since 14th April 2023
Astra Microwave Products Ltd. 508.09 595.70 307.70 93.59%
Bharat Dynamics Ltd. 2545.22 1751.30 1004.55 74.33%
Bharat Electronics Ltd. 26558.23 201.45 103.30 95.01%
Bharat Forge Ltd. 9434.60 1129.45 800.85 41.03%
Cochin Shipyard Ltd. 487.29 871.45 251.67 246.26%
Hindustan Aeronautics Ltd. 14990.89 3327.25 1460.70 127.78%
Mazagaon Dock Shipbuilders Ltd. 180.40 1860.90 754.30 146.70%
MTAR Technologies Ltd. 750.99 1683.65 1814.80 -7.22%
Premier Explosives Ltd. 152.28 1518.10 418.00 263.18%
Solar Industries India Ltd. 10951.52 8786.05 3821.65 129.90%
Defence Sectors Funds are also included.
#Portfolio data as of March 31, 2024
Market Price data as per the stock exchange data.
Past performance is not an indicator of future returns.(Source: NSE, data collated by PersonalFN Research)
 

As seen in Table 1, many companies in the defence sector, such as Mazagaon Dock Shipbuilders, Cochin Shipyard, and Premier Explosives, among others have delivered handsome returns since August last year. Many mutual fund schemes have held respectable exposure to defence stocks, enabling them to benefit from their rally.

[Read: Keep Your Money Safe and Liquid During Election Jitters: Take a Look at Liquid Funds]

Out of a total of 267 diversified equity mutual fund schemes taken into consideration and one defence sector-specific scheme, at least 1 scheme has invested in at least one defence stock as per the portfolio as of March 31, 2024. Nine schemes have an exposure of 5% or more, 38 have an exposure of around 3-4%, 110 mutual fund schemes have an exposure between 1% and 2%, and 30 schemes have an exposure of less than 1% to defence stocks.

Table 2: Top-6 Fund houses with high exposure to defence stocks in their equity schemes

Fund House Name Exposure as a % of the Equity AUM
NJ Mutual Fund 6.95%
ITI Mutual Fund 3.09%
Kotak Mutual Fund 3.08%
Invesco Mutual Fund 3.04%
Canara Robeco Mutual Fund 2.96%
HDFC Mutual Fund 2.07%
Portfolio data as of March 31, 2024
(Source: ACE MF, data collated by PersonalFN Research)
 

At the fund house level Kotak Mutual Fund, Invesco Mutual Fund, NJ Mutual Fund, and ITI Mutual Fund have a noticeable exposure to India's defence sector.

Speaking of the equity mutual fund scheme, here are the five having high exposure to defence stocks...

Table 3: Top 6 diversified equity funds with high exposure to defence stocks

Scheme Name Exposure as a % of the portfolio
HDFC Defence Fund 65.29
360 ONE Quant Fund 9.99
Kotak Emerging Equity Fund 9.67
DSP India T.I.G.E.R Fund 8.52
Edelweiss Mid Cap Fund 8.27
HSBC Infrastructure Fund 7.14
Portfolio data as of March 31, 2024
(Source: ACE MF, data collated by PersonalFN Research)
 

Recently launched, HDFC Defence Fund, which is a sector-specific scheme, currently has 65.29% exposure to defence stocks. Besides, it invests in allied companies that are in defence-related activities.

#1: HDFC Defence Fund

Launched in June 2023, HDFC Defence Fund, under normal circumstances, has the mandate to invest 80% to 100% of its assets in equity and equity-related instruments of Defence & allied sector Companies. Currently, the fund holds a concentrated portfolio of 24 stocks, wherein a majority are largecaps (42.11%) and the remaining 8.26% and 41.91% are midcaps and smallcaps.

Table 4: Top defence stock holdings of HDFC Defence Fund

Stocks % of assets
Hindustan Aeronautics Ltd. 20.53
Bharat Electronics Ltd. 17.40
Solar Industries India Ltd. 8.27
Astra Microwave Products Ltd. 6.58
MTAR Technologies Ltd. 5.88
Premier Explosives Ltd. 5.08
Bharat Dynamics Ltd. 1.56
The securities quoted are for illustration only and are not recommendatory.
Data as of 31st March 2024
(Source: ACE MF, data collated by PersonalFN Research)
 

Among the defence stocks, Hindustan Aeronautics, Bharat Electronics, Astra Microwave Products Ltd., and Solar Industries India, are among the top-5 defence stocks as of March 31, 2024. Then among the allied ones are those in the engineering and capital goods space, such as MTAR Technologies Ltd., Premier Explosives Ltd., Bharat Dynamics Ltd., and so on, which are also engaged in the defence business. Want to know the other stocks in the HDFC Defence Fund's portfolio? Visit its factsheet here.

Note, HDFC Defence Fund, after receiving a good response for its NFO and recognising that its investment universe is limited (total 24 stocks), has restricted fresh investments. This is done to preserve the overall investment strategy and safeguard the interests of current investors.

[Read: HDFC Mutual Fund Restricts Lumpsum Investments in HDFC Defence Fund. Here's Why]

#2: 360 ONE Quant Fund

Launched in November 2021 amidst the COVID-19 pandemic, 360 ONE Quant Fund (from the stable of 360 ONE Mutual Fund, erstwhile known as IIFL Mutual Fund) is a thematic fund pursuing a quant approach for its portfolio construction activity. As per its March 2024 portfolio, the fund has 9.99% exposure to key defence stocks (out of a total portfolio of 37 stocks).

Table 5: Top defence stock holdings of 360 ONE Quant Fund

Stocks % of assets
Hindustan Aeronautics Ltd. 4.10
Bharat Electronics Ltd. 3.40
Bharat Forge Ltd. 2.49
The securities quoted are for illustration only and are not recommendatory.
Data as of 31st March 2024
(Source: ACE MF, data collated by PersonalFN Research)
 

The top-10 stocks comprise 38.25% of the current portfolio, and the defence stocks, such as Hindustan Aeronautics and Bharat Electronics, are very much a part of it. The overall portfolio as of March 2024 of 360 ONE Quant Fund is mainly in midcaps (51.19%) and the remaining (46.93%) in largecaps.

#3: Kotak Emerging Equity Fund

Launched in March 2007 as a mid and small cap fund, was recategorised as a mid cap fund after SEBI's recategorisation and rationalisation norms. At present, Kotak Emerging Equity Fund aims to generate long-term capital appreciation from a portfolio of equity and equity-related securities by investing predominantly in mid-companies. The fund holds a well-diversified 78 stocks in line with its investment mandate.

Table 6: Top defence stock holdings of Kotak Emerging Equity Fund

Stocks % of assets
Solar Industries India Ltd. 4.56
Bharat Electronics Ltd. 2.80
Bharat Forge Ltd. 2.31
The securities quoted are for illustration only and are not recommendatory.
Data as of 31st March 2024
(Source: ACE MF, data collated by PersonalFN Research)
 

The top 10 stocks comprise 32.65% of the portfolio, of which Solar Industries -- a defence stock -- is one of them. The other defence stocks in its portfolio are Bharat Forge and Bharat Electronics. Kotak Emerging Equity Fund's overall exposure to defence stocks is 9.67%

By holding a robust portfolio by following a bottom-up approach to stock picking and buy-and-hold strategy, overall Kotak Emerging Equity Fund has lived up to its mandate and rewarded investors with superior risk-adjusted returns. It is one of the top performers among the mid cap funds.

#4: DSP India T.I.G.E.R Fund

Launched in June 2004, the DSP India T.I.G.E.R Fund, in line with its mandate which aims to from a portfolio that is substantially constituted of equity securities and equity related securities of corporates, which could benefit from structural changes brought about by continuing liberalization in economic policies by the Government and/ or from continuing investments in infrastructure, both by the public and private sector.

Table 7: Top defence stock holdings of DSP India T.I.G.E.R Fund

Stocks % of assets
Hindustan Aeronautics Ltd. 3.17
Solar Industries India Ltd. 1.88
Bharat Electronics Ltd. 1.46
Bharat Forge Ltd. 1.23
Bharat Dynamics Ltd. 0.79
The securities quoted are for illustration only and are not recommendatory.
Data as of 31st March 2024
(Source: ACE MF, data collated by PersonalFN Research)
 

The scheme holds overall exposure of 8.525 in defence stocks. Hindustan Aeronautics Ltd. is DSP India T.I.G.E.R Fund's top defence holding also featuring in the top 10 stocks of the scheme. Overall, the fund holds a well-diversified portfolio of 73 stocks in congruence with its investment mandate of investing in midcaps. The scheme follows a bottom-up approach to stock selection to pick good and sound businesses.

#5: Edelweiss Mid Cap Fund

Launched over a decade ago in January 2013, formerly as Edelweiss Mid and Small Cap Fund, after the mutual fund categorisation and rationalisation norms was re-categorised as a mid-cap mutual fund scheme. The fund at present aims to generate long-term capital appreciation from a portfolio that predominantly invests in equity and equity-related securities of midcap companies. In line with that, Edelweiss Mid Cap Fund holds 66.94% of its equity portfolio in midcap, 13.95% in smallcaps, and the balance (17.28%) in largecaps.

Table 8: Top defence stock holdings of Edelweiss Mid Cap Fund

Stocks % of assets
Solar Industries India Ltd. 2.91
Bharat Electronics Ltd. 1.97
Bharat Dynamics Ltd. 1.84
Mazagon Dock Shipbuilders Ltd. 0.86
Bharat Forge Ltd. 0.69
The securities quoted are for illustration only and are not recommendatory.
Data as of 31st March 2024
(Source: ACE MF, data collated by PersonalFN Research)
 

The fund currently has 74 stocks in its portfolio, and the top 10 holdings comprise 33.31% of the portfolio. However, the fund holds only Solar Industries India Ltd. from the aforementioned defence stocks in the top-10 holdings. The overall exposure to defence stocks is 8.27% of its total assets.

#6: HSBC Infrastructure Fund

Launched in September 2007, this fund seeks to generate capital appreciation by investing predominantly in equity and equity related instruments of companies in the Infrastructure sector. Bharat Electronics is part of the top 10 holdings of the fund.

Table 9: Top defence stock holdings of HSBC Infrastructure Fund

Stocks % of assets
Bharat Electronics Ltd. 7.14
The securities quoted are for illustration only and are not recommendatory.
Data as of 31st March 2024
(Source: ACE MF, data collated by PersonalFN Research)
 

With 59 stocks in its portfolio and top-10 stocks comprising 38.60%, the overall equity portfolio of HSBC Infrastructure Fund is well-diversified -- at present, 47.15% in largecaps, 14.90% in midcap, and the remaining 35.68% in smallcaps. The fund is almost fully invested with only around 4% of its total assets in debt and cash.

 

How have mutual fund schemes betting on the defence sector performed?

Diversified equity mutual fund schemes with only some portion of their equity portfolio held in defence stock have underperformed vis-a-vis the Nifty India Defence - TRI (which mainly tracks the performance of listed defence companies).

Table 10: Performance of mutual fund schemes betting on defence stocks

Scheme Name Absolute CAGR Ratio
6 Months 1 Year 2 Years 3 Years 5 Years 7 Years SD Annualised Sharpe
Kotak Emerging Equity Fund 16.21 42.29 21.18 24.24 23.57 18.29 13.66 0.40
Edelweiss Mid Cap Fund 24.63 54.88 26.26 28.02 26.03 20.36 15.70 0.41
DSP India T.I.G.E.R Fund 30.78 71.40 37.65 37.41 25.52 18.98 15.64 0.54
HSBC Infrastructure Fund 23.77 57.78 31.47 33.64 22.19 17.14 16.21 0.47
ITI Mid Cap Fund 31.95 66.09 32.00 25.52 - - 15.69 0.37
360 ONE Quant Fund 27.62 64.31 28.24 - - - 17.46 0.35
HDFC Defence Fund 47.26 - - - - - 17.66 1.07
NIFTY 100 - TRI 16.61 31.06 14.39 16.95 15.13 14.69 0.27 14.11
NIFTY 50 - TRI 12.64 25.64 13.81 16.17 14.75 14.81 0.26 13.71
NIFTY 500 - TRI 17.79 37.89 17.22 19.63 17.09 15.47 0.31 14.40
Nifty India Defence - TRI 55.29 131.53 - - - - 0.84 21.19
Nifty Midcap 150 - TRI 20.71 57.49 26.60 27.67 23.94 18.83 0.39 16.64
Nifty Smallcap 250 - TRI 22.26 67.91 24.95 30.34 23.53 15.85 0.36 19.41
S&P BSE SENSEX - TRI 10.63 22.30 13.20 15.68 14.51 15.17 0.25 13.71
Data as of April 16, 2024
The securities quoted are for illustration only and are not recommendatory.
Direct Plan-Growth option considered.
Returns considered are point-to-point and expressed in %.
Returns over 1 year are compounded annualised; else absolute.
Standard Deviation indicates Total Risk, while Sharpe and Sortino Ratios measure the Risk-Adjusted Return. They are calculated over a 3-Yr period assuming a risk-free rate of 6% p.a
Past performance is not an indicator of future returns.
The table above is NOT a recommendation as such. Speak to your investment advisor for further assistance before investing.
Mutual Fund investments are subject to market risks. Read all scheme-related documents carefully.
(Source: ACE MF; Data collated by PersonalFN Research)
 

That being said, the positive performance of certain defence stocks (along with non-defence stocks) in their portfolio has helped diversified equity mutual funds, such as Kotak Emerging Equity Fund and Edelweiss Mid Cap Fund, to deliver returns almost in line with their midcap benchmark index.

The Outlook for the Defence Sector in India

India's defence minister, Mr. Rajnath Singh has dubbed the Indian defence industry as the sunrise sector of the future. The Indian government is consistently increasing its defence spending. The 'Make in India' (indigenisation) drive, with emphasis on 'Aatmanirbharta' (self-reliance) in defence, is expected to augur well. Several defence companies in India have a strong and growing order book. Moreover, the book-to-bill ratio (which is the ratio of new orders received to the units billed) of many defence companies is attractively placed.

India is aiming to become a net exporter of defence equipment. The government has set an ambitious target of Rs 35,000 crore of defence exports by 2025. In other words, the defence sector has got enough steam and many tailwinds working in its favour.

That said, many defence stocks are already at their multi-year high (all-time highs in some cases). This is a challenging scenario if you are considering direct investment in defence stocks. It would be worthwhile taking exposure to the defence theme via some of the best-diversified equity mutual funds. Mutual fund schemes holding fundamentally sound defence stocks with encouraging order books (and having the capability to execute orders on time) are likely to benefit and generate wealth for investors in time to come.

Happy Investing!

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ROUNAQ NEROY heads the content activity at PersonalFN and is the Chief Editor of PersonalFN’s newsletter, The Daily Wealth Letter.
As the co-editor of premium services, viz. Investment Ideas Note, the Multi-Asset Corner Report, and the Retire Rich Report; Rounaq brings forth potentially the best investment ideas and opportunities to help investors plan for a happy and blissful financial future.
He has also authored and been the voice of PersonalFN’s e-learning course -- which aims at helping investors become their own financial planners. Besides, he actively contributes to a variety of issues of Money Simplified, PersonalFN’s e-guides in the endeavour and passion to educate investors.
He is a post-graduate in commerce (M. Com), with an MBA in Finance, and a gold medallist in Certificate Programme in Capital Market (from BSE Training Institute in association with JBIMS). Rounaq holds over 18+ years of experience in the financial services industry.


Disclaimer: Investment in securities market are subject to market risks, read all the related documents carefully before investing.
This article is for information purposes only and is not meant to influence your investment decisions. It should not be treated as a mutual fund recommendation or advice to make an investment decision in the above-mentioned schemes.

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