Defense investment funds are losing their shine, falling by up to 5% in a month. Should you invest more?

Defense sector based mutual funds (including assets and passive funds) have lost up to 5% in the last month. These schemes gave an average negative return of around 4.04% in the said period. Only two funds based on the defence sector have completed a month of existence in the market. In the last month, Nifty India Defence – TRI also lost around 5.13%.

Motilal Oswal Nifty India Defence Index Funda passive fund based on the defence sector, lost the largest chunk, around 5.21%, in the last month. Launched in July 2024, the scheme manages assets of Rs 2,330 crore as of July 2024.

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HDFC Defence Fundthe only one active fund Based on the defence sector, it lost around 2.86% in the said time period. Launched in June 2023, the scheme manages assets worth Rs 3,930 crore as of July 2024.

Defense sector mutual funds have delivered stellar performance over a period of time. What factors caused these funds to deliver negative returns in the past month?

“Defence stocks had rallied significantly over the last one year or so on the back of a robust order book and a significant rise in defence exports. The sector has also benefited immensely from the government’s increased defence spending, with a focus on indigenisation and modernisation. However, high valuations coupled with lower than expected budget outlay for the sector in the recent budget has led to a correction in defence stocks over the last one month or so,” said Nilesh D Naik, Head – Investment Products, Share.Market. Lump sum subscriptions and systematic transactions have been stopped in HDFC Defence Fund with effect from July 22, 2024. The defence sector emerged as an attractive option among mutual funds as many mutual funds launched new funds based on this sector.

Following the launch of HDFC Defence Fund a year ago, Motilal Oswal introduced Nifty India Defence Index Fund. Recently, Groww Mutual Fund and Aditya Birla Sun Life Mutual Fund have also launched passive funds based on the defence sector. Groww Nifty India Defence ETF and Aditya Birla SL Nifty India Defence Index Fund are still in their NFO period. Motilal Oswal Mutual Fund has also filed a draft document with Sebi for a defence sector-based ETF.

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HDFC Defence Fund, the only fund to have completed a year in its category, has returned 101% in the last one year. In the last six and three months, the fund has returned 41.42% and 11.60% respectively.

Following a stellar performance by defence sector mutual funds, recent performance has been subdued. The question is whether investors should be concerned about their current investments in these funds or should make further allocations at this time.

“Defence is a very specific theme and hence the volatility of funds that track that theme can be significantly higher than that of diversified funds. Therefore, most investors will be better off investing in more diversified funds for their long-term investment needs and letting professional fund managers manage the allocation to individual sectors and themes,” Naik advised.

He also mentioned that “sector or thematic funds should never be part of an investor’s core investments. Only experienced investors with a very high risk tolerance and a deep understanding of the dynamics of individual sectors in terms of growth, profitability, valuations, risks, etc. could consider making a tactical allocation to specific sectors and themes based on their views.”

As for current performance, one analyst mentioned that defense stocks are currently experiencing corrections after having far outperformed fundamentals.

“Some segments, such as defence-related stocks, which have been outperforming fundamentals by a large margin, are witnessing corrections,” said Dr VK Vijayakumar, chief investment strategist at Geojit Financial Services.

Looking at recent performance, will defence-based mutual funds continue to perform similarly or offer good returns? What is the outlook for these funds or the sector?

Commenting on the performance of defence and shipbuilding stocks, Daljeet Kohli of Roha Asset Managers LLP told ET Now, “I would say these stocks are valued way ahead of schedule. So, whether the party is over or not, it will depend on this issue as to how much it continues or whether the liquidity keeps coming and people find that this is a sector where there is a lot of growth and a lot of potential. We all believe in all those things. But the question is at what valuation you go in. So, if someone had gone in a year or two years ago, as you said right then, it was something that was undervalued, but you have probably paid for the next five years of growth in most of these stocks.”

He added: “Therefore, the only way to arrive at a rational valuation would be a temporary correction. So, in any case, we have not invested in any of these stocks and, in fact, we do not recommend investing in them even after a 20% correction because we believe that their valuation is way ahead of its deadline. They are all good companies, they will continue to perform well, but they have already been paid for the next four or five years of performance.”

We consider all the defense sector mutual funds available for investment. We consider regular and growth options. We calculate the returns for the last month.

(Disclaimer:The recommendations, suggestions, views and opinions of the experts are their own and do not represent the views of The Economic Times.

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