India’s defence sector mutual funds have taken off, delivering remarkable returns of up to 60% over the past three months. As market trends shift in favor of strategic national interests, investors are taking note—but should they dive in now or wait for a correction?
Strong Performance Driven by Policy and Earnings
Currently, six mutual fund schemes focused on the defence sector—spanning both active and passive styles—have posted an average return of 57.70% in just three months. Three of these funds surpassed the 60% mark, underscoring the momentum in this niche space. Among active funds, the HDFC Defence Fund stands out, delivering a robust return of 45.93%.
Experts attribute this strong performance to several key drivers: a supportive policy environment, impressive quarterly earnings from defence companies, and increased capital spending. Notably, the FY25 Union Budget allocated ₹1.72 lakh crore towards defence capital outlay, reflecting a push for indigenization. According to Atul Shinghal, CEO of Scripbox, this policy focus, combined with a 12% year-on-year rise in defence exports to ₹21,083 crore in FY24, has significantly boosted investor confidence.
Meanwhile, geopolitical developments—such as heightened tensions between India and Pakistan—have further fueled interest in the sector, acting as a short-term catalyst for the rally.
Valuations Raise Caution Despite Optimism
While the rally has been impressive, analysts are urging investors to remain cautious. The Motilal Oswal Nifty India Defence Index, a widely tracked benchmark, is trading at a P/E ratio of 61.35x and a P/B ratio of 13.22x—both significantly above market averages. This suggests that current valuations may have run ahead of fundamentals.
Shinghal highlighted another concern: the Sharpe Ratio for the index is negative at -0.07, signaling weak risk-adjusted returns despite high absolute gains. With about 77.5% of the index allocated to mid and small-cap stocks, the sector could see sharp corrections during broader market downturns.
Market analyst Naik echoes this sentiment. He recommends that only seasoned investors with well-diversified core portfolios consider thematic funds like defence. “Several defence stocks are trading close to their record highs. While the sector’s long-term outlook remains intact, entering at current levels may be risky,” Naik said.
For investors seeking high-potential yet calculated exposure, a staggered investment approach may be more appropriate. Booking profits, reducing exposure slightly, and re-entering after a market correction could be prudent strategies.
Key Takeaways and Investment Outlook
The surge in defence sector mutual funds highlights a growing investor appetite for strategic, government-backed themes. Still, with lofty valuations and concentrated exposure to volatile mid-cap stocks, this theme may not suit every portfolio.
Investors should weigh their risk appetite and financial goals before jumping into the current rally. While the long-term growth story for India’s defence industry remains strong, experts suggest waiting for better entry points.
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