Investment in the defence industry has increased significantly; over the past three months, the Nifty India Defence TRI Index has increased by 64%. The remarkable growth can be owed to India’s top defence and attack showcases through Operation Sindoor. The mutual funds have also returned quality funds during the period, further enhancing the interest of the investors. Currently, there exists one active defence index fund and four defence ETF options available for investment. But is it worth the investment for the upcoming times? Let’s understand this by gaining insights about the growth of defence mutual funds in India.

What Are Defence Mutual Funds?

Defence mutual fund is a mutual fund that invests in defence, including military and homeland security. It is a part of sectoral or thematic mutual funds. It involves investment in companies such as defence equipment manufacturers, government-linked defence suppliers, aerospace technology firms, and others. These funds aim to enhance technological advancements and pave the way for long-term growth of the sector.

Why Are Defence Mutual Funds Gaining Popularity in India?

The growth of defence mutual funds in India can be attributed to:

Government-Driven Growth Initiatives

The Indian Government is strongly promoting policies like AtmaNirbhar Bharat and Make in India to encourage domestic production. Thus, promising usage of funds is certain.

Increase in Defence Spending

India’s defence budget for FY25 is at INR 6.2 lakh crore, and the capital expenditure is expected to grow at an equivalent of 15% CAGR till FY30. These figures indicate the long-term transition from personnel costs to modernisation and capacity building, thus boosting defence stock prospects.

Expansion in Exports

Over 85 countries now import defence products from India, thus improving revenue gains.

Long-Term Order Visibility

Multiple top companies in India are operating under robust order backlogs. They have strong growth potential demonstrated through their high earnings and Return on Equity (RoE). Further, their global presence adds to the enhanced interest in defence ETF and defence index fund investments.

Stability in the Sector

The defence contracts are generally long-term and government-backed. Thus, they offer stable revenue streams. It means the investments are recession-resistant, thus contributing to their popularity.

Quality Mutual Fund Returns

The Nifty India Defence TRI surged around 60% in 3 months. The defence ETF and defence index fund have delivered short-term returns ranging from 28 to 60%, attracting momentum-driven investors.

Alignment with National Sentiment

One of the important factors driving the popularity of defence mutual funds is the alignment with nation’s strategic interest in defence as a sector. The display of advanced technology and products during Operation Sindoor exhibited India’s defence capabilities amid geopolitical tensions. Hence, investors aren’t just making financial investments but also contributing to the strategic upliftment of the country.

Favourable Policy Reforms and FDI Norms

FDI cap in defence has increased to 74% via the automatic route. This encourages private sector participation and has enhanced research, leading to innovation and scalability in listed companies. Such developments have placed Indian offerings among the best aerospace and defence ETF options in emerging markets.

Benefits of Investing in Defence Mutual Funds

Growth potential, quality returns and resilience characterise the investment in this sector. Hence, the defence mutual funds offer multiple benefits for the investors. They are as follows:

• Stability: The long-term government contracts offer protection from the short-term market volatility and economic downturns. They ensure consistent revenue for the investors, making it a relatively stable investment avenue.

• Portfolio diversification: The investors get exposure to a non-cyclical government-backed sector. It helps reduce the overall portfolio risk and provides smooth returns.

• Export growth: The defence-based exports are increasing, and hence, there is the possibility of gaining quality returns from around the globe. Thus, investors can expect improved earning potentials.

• Technical progress: The support from the funding towards the research sector is leading to rapid progress in artificial intelligence, better cybersecurity and unmanned systems. The expected result is the development of cutting-edge products. Thus, investors can expect to benefit from innovation-driven growth and future-ready technologies.

Factors Determining Investment in the Defence Sector

While the defence sector is witnessing growth in terms of investments, the suitability for specific cases depends on various factors. Here are insights into the same:

• High concentration risk: The defence mutual fund investments are generally made only in 4 to 5 companies. Hence, the portfolio’s performance has increased exposure to individual stock volatility.

• Valuation risk: The rapid interest in these stocks has led to costly shares. It is reflected in a high Price to Earnings (P/E) ratio and Price to Book (P/B) ratio. This is associated with limited future return potential or increased correction risks.

• Sector-based risks: The change in government defence policies, cuts in budget allocation or procurement delays can impact the expected returns. Further, the sector is also prone to price changes attributed to geopolitical events, international relations and contract announcements, leading to the unpromised fate of investment.

• Project delays: Delays in certain large-scale defence projects can hamper revenue generation. The impact will be translated into mutual fund performance as well.

Conclusion

Defence mutual funds, including defence stock index fund and defence ETF, represent a promising opportunity for investors. Factors like increasing government expenditure in the sector, long-term growth potential, showcased advancements, and expansion in export capabilities offer promising opportunities for wealth creation. The investment in defence mutual funds is also in alignment with national pride. While the sector presents worthy opportunities to obtain potentially higher returns in future, there remain certain risks to consider before making a decision. Sector-specific risks, high stock concentration, possible influences due to geopolitical events and other factors must be thoroughly considered to ensure an informed investment decision .

The sector(s)/stock(s)/issuer(s) mentioned in this presentation do not constitute any research report/recommendation of the same and the Fund may or may not have any future position in these sector(s)/stock(s)/issuer(s).

Mutual Fund investments are subject to market risks, read all scheme related documents carefully.