In countries where a close linkage of sectors with national security prevails, government spending on defence has become a prime driver of growth. The emphasis of the Government of India on defence and security across nations has resulted in excellent returns to mutual funds investing in defence-themed sectors. An example in this regard is the Indian defence sector, replete with a potential bigger than the sea itself because of substantial government investments throughout successive regimes. The following paper tries to explain how mutual fund returns are influenced by augmented defence spending using recent data and trends for the Indian defence market.
Overview of Defence Spending in India
India’s defence spending has grown over the last decade at a faster clip compared to world averages. In the last ten years, global defence spending has seen a rise of only about 3%, whereas India’s growth rate has been at an impressive 10%. Aggressive growth and policy reforms to strengthen indigenous manufacturing have transformed this sector into some of the most promising investment opportunities. Thus, the defence sector tops the chart, moving ahead of other sectors on the returns front with a whopping 200% in the past year.
According to the Ministry of Defence, domestic defence production touched an all-time high of ₹1.3 lakh crore in 2023-24, marking a growth of 16.7% over the previous fiscal year. The government’s policy initiatives for indigenisation of defence production and reduction in import dependence have opened several avenues for innovation and competition, with the private sector at the forefront of this endeavour.
This has laid the foundation for most defence companies to expand, thus offering an excellent opportunity for mutual funds to benefit from the industry’s growth.
Performance of Mutual Funds: The Defence Theme
The funds concentrating on the defence industry have shown highly remarkable performance. For example, if one had invested Rs 10,000 systematically in a defence-themed mutual fund every month since its launch, it would have grown today to 2.28 lakh, thus resulting in an XIRR of 147.90%. If Rs 1 lakh were invested in it through a lump sum, this would have grown to Rs 2.45 lakh, translating into a CAGR of 122.95%. Such is the heady return that underlines the potential of the defence sector for wealth creation, given their spending by the government.
India’s defence budget is among the world’s highest, at Rs 6.21 lakh crore for FY24, or about 2.5-3% of GDP. This near-continuous increase in expenditure acts as a catalyst to drive the growth of the defence sector. Hence, the next data point is mirrored in the mutual fund returns tracking this space.
For example, the only mutual fund that pioneered investment in the defence sector was HDFC Mutual Fund, which generated more than 128% return in the last year.
Role of Defence-Focused Index Funds
For mutual fund investors, funds related to the defence theme are usually based on or linked to a specialized index like the Nifty Defence Index. The index indicates the performance of companies engaged in the defence-related business and gives a broad basket of stocks in that particular segment. Some of the contributors to the index are heavyweight companies like Bharat Electronics, Hindustan Aeronautics, and Solar Industries, among others, which indicate the sector’s general performance.
The Nifty Defence Index reflects this strong performance, indicating a trailing PE ratio of 71.8 and PB ratio of 19.39, over three times that of the broad Nifty 50 index. Such valuations seem stretched; however, they point to the optimism that the market has for the long-term growth potential in defence stocks.
Benefits of Investing in Defence-oriented Mutual Funds
Thus, the benefits of investing in funds such as HDFC Mutual Fund, which tracks the Nifty Defence Index, are myriad. The benchmark for this specific fund is the Nifty India Defence Index TRI (Total Returns Index). However, the benefits can be listed as:
- Sectoral focus:
Mutual funds tracking defence indices are concentrated in the defence sector, which is less volatile owing to steady government spending and long-term contracts. This helps diversify even when it belongs to only one sector by having an equity portfolio of companies engaged in various activities within the defence sector related to production, research, and development. - Long-term Growth Prospects:
While India has the vision to double domestic defence production and export more than Rs 50,000 crores worth of defence equipment by 2028-29, mutual funds invested in defence stocks stand a good chance of gaining significantly. Risks Involved While mutual funds focused on defence have high potential, they also carry risks: - Valuation Risks:
As mentioned above, the sector’s current valuations are already high and can result in short-term volatility. Therefore, investors need to be extra cautious when investing when valuations are stretched since any correction in the stock market might result in a fall in returns. - Government Policy Dependency:
The defence sector is heavily dependent on government policies. Any reduction in defence spending or changes in policy direction could adversely impact the sector’s growth and, thereby, the performance of mutual funds. - Long Execution Timelines:
Defence companies typically have a long project execution timeline that delays revenue realisation and impacts immediate profitability.
Here, it can be inferred that mutual fund return is affected by the government’s defence spending: higher spending begets growth in the defence sector, which gets reflected back in high returns for the investors. While mutual fund performance––more specifically, this can be related to defence-themed mutual funds––has been extraordinarily good due to an increase in India’s defence budget, thrust in indigenous production, and export ambitions, the investors should understand the risks in the sector about factors such as valuation and dependence on government policies.
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To wrap it up
For investors looking to diversify their portfolio against views of capitalising on a fast-growing sector, the defence-themed mutual fund is a strong opportunity. It entails investment in an important industry poised for long-term growth and has very strong government support, always focused on national security.
For those seeking to diversify their portfolio while capitalising on a growing sector, defence-themed mutual funds provide a compelling opportunity. They offer exposure to a vital industry that is poised for long-term growth, backed by strong government support and an ever-increasing focus on national security.
