The new fund offer for HDFC Defence Fund is active, marking a milestone as the first-of-its-kind for the sector in the country.
The fund focuses on the defence sector, which has garnered investor attention, and aligns with the government’s initiative to promote indigenisation of defence manufacturing and defence export promotion.
The objective of the sectoral fund is to generate long-term income or capital appreciation by primarily investing in equity and equity-related instruments of defence and allied sector companies.
With a promising outlook for the Indian defence sector, the fund aims to capitalise on the prospects. In the investor presentation for the defence fund, HDFC Mutual Fund said that defence companies have reported “healthy growth in revenues”, despite the yet-to-be-realised material benefit of indigenisation and exports.
According to the corporate and government data shared by HDFC Mutual Fund, the revenue of defence companies grew at a CAGR of 8%, between 2017 and 2022.
The fund house also said that defence companies have consistently displayed a healthy return profile. The average return on equity for the sector remained in the high teens between 2017 and 2022.
According to data from the Ministry of Defence, the government has increased budgetary allocation to the sector. In Union budget 2024, the allocation for the sector stands at Rs 5.94 lakh crore, a 13% increase as compared with the previous year. Capital outlay for modernisation and infrastructure development has been raised to Rs 1.62 lakh crore, up 57% since FY20.
However, HDFC Defence Fund, like any other sector fund, faces risks due to lack of diversification. This means that any disruptions in the defence sector will directly affect the scheme’s returns. Also, the scheme carries the risk associated with buyer concentration as the “government of India is large buyer to meet requirements of defence forces, etc.”
The fund is also susceptible to policy changes made by both Indian and foreign governments, as these changes can have significant ramifications for the defence sector and, consequently, for the fund.
The new fund offer for the HDFC Defence Fund, which opened on May 19 was supposed to run till June 2, but will now close on May 30. The core portfolio of the fund "will be listed companies that obtain at least 10% of revenues from defence segment". The Nifty India Defence Index TRI will serve as the benchmark for the fund.
Expert Insights
Experts have issued a word of caution regarding the HDFC Defence Fund on account of its sectoral nature and concentrated portfolio.
Kirtan Shah, founder at Credence Wealth Advisors, said that the entire premise of investing in sectoral or thematic bets is about timing the market correctly. While NFOs are launched when it’s a good time to invest in the sector, Shah says retail investors may not be adept at reading the market and may find it difficult to exit at a profitable point.
Prableen Bajpai, founder of Finfix Research and Analytics, concurred and said that first-time investors should not invest in the fund as they might not be savvy enough to time the market right.
Shah also emphasised the lack of diversification, a key pitfall for sectoral funds, as a reason for staying away from HDFC Defence Fund.
"There is a chance that diversified funds would have some exposure to defence stocks. If you are invested in one, then see if there is an overlap," said Bajpai.
According to Bajpai, the higher risk associated with the HDFC Defence Fund stems from its investible universe, which consists of 21 companies, of which 18 are small-cap firms.
The investor presentation for the fund shows that these 18 small-cap companies contribute to 28% of the total market capitalisation within the investible universe. Overall, the sector comprises 21 companies, including two large-cap and one mid-cap company, collectively representing a market cap exceeding Rs 2.99 lakh crore.
Regarding the timing of the scheme, Bajpai said that the HDFC Defence Fund entered the market relatively later, as the sector has already witnessed a surge in demand. The government’s initiatives to push indigenisation and exports have fuelled investor interest in defence stock, she said.
"The sector can see a few good years with the rise in Make in India and exports," said Bajpai.
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