Mutual Funds: These two AMCs have recently launched defence index funds: Should you invest?

In the last few years, defence as an investment theme has done well on the stock exchanges. The shares of some of the listed defence companies, like HAL, BEL, etc., have become multi-baggers and created wealth for their investors. Many investors have flocked to listed defence companies. 

Looking at the investors’ preference for listed defence companies, two AMCs have launched defence index funds in the last few months. Let us look at what these defence index funds are, the companies that are a part of them and their performance, and whether you should invest.

What is the Nifty India Defence Index?

Two AMCs have launched index funds on the Nifty India Defence Index. Motilal Oswal Mutual Fund launched the Motilal Oswal Nifty India Defence Index Fund in June 2024. Aditya Birla Sun Life Mutual Fund launched the Aditya Birla Sun Life Nifty India Defence Index Fund in August 2024. So, before we get into the scheme details let us take a look at the Nifty India Defence Index.

The Nifty India Defence Index has 15 constituents. The index tracks the performance of these companies that broadly represent the defence theme. The top 10 constituents and their weightages include the following:

(Source: https://www.niftyindices.com/Factsheet/Factsheet_NiftyIndiaDefence.pdf)

Note: The above data is as of 31st August 2024.

Nifty India Defence Index performance

Let us now look at the performance of the Nifty India Defence Index. The index has a base date of 2nd April 2018 and a base value of 1,000.

(Source: https://www.niftyindices.com/Factsheet/Factsheet_NiftyIndiaDefence.pdf) 

Note: The above data is as of 31st August 2024.

The above chart shows the spectacular rise the index has seen since April 2018. As of September 2024, the index is trading at levels above 7,000. In the last 6.5 years, the index has multiplied investor money more than seven times.

(Source: https://www.niftyindices.com/Factsheet/Factsheet_NiftyIndiaDefence.pdf)

Note: The above data is as of 31st August 2024. The YTD and 1-year returns are absolute, and the 5-year returns are CAGR.

The above table shows how the index has given excellent returns in the last one and five years and, thus, created tremendous wealth for investors.

As of 31st August 2024, the index trades at a Price to Earnings (P/E) ratio of 56 times and a Price to Book (P/B) ratio of 16 times. So, the valuations of the index are expensive.

How are the index constituents performing?

In the above section, we saw how the index has performed very well in the last few years. Now, let us look at the performance of the index constituents. Let us take the example of Hindustan Aeronautics Limited (HAL), which has the second-highest weight (18.23%) in the index.

Let us look at the company’s financial performance and the stock price performance of HAL. Hindustan Aeronautics Limited is one of the biggest defence PSUs in India. It designs, manufactures, and services aircraft, helicopters, etc., for the defence forces. In the last four years, the company has grown its annual profits from over Rs. 2,800 crores (FY 2020) to more than Rs. 7,600 crores (FY 2024) at a 32.9% CAGR. At the end of FY 2024, the company recorded revenues of more than Rs. 30,000 crores.

At the end of FY 2024, the company had a huge order book of Rs. 94,000 crores, which is more than three times the FY 2024 revenues. So, the company has good revenue visibility for the next few years. The Government of India is focusing on strengthening India’s Defence Forces with higher annual budgetary allocations. The budgetary allocations will translate into huge orders for defence companies like HAL. Hence, the order pipeline for HAL and other defence companies is very strong.

With a huge order book outstanding and future order inflows expected, the timely order book execution, margins, receivables, etc., are key monitorable for the company. Based on the past good financial performance and in anticipation of future execution of the order book, the company share price has done exceedingly well.

(Source: https://trendlyne.com/equity/80502/HAL/hindustan-aeronautics-ltd/)

Note: The data is as of 5th September 2024.

The above chart shows how the HAL share price has shot up from Rs. 336 in September 2019 to Rs. 4,792 in September 2024. In the last five years, the stock price has multiplied more than 14 times, creating huge wealth for its shareholders.

Will the share price performance of listed defence companies continue?

We saw the performance of the overall index and one of its constituents, HAL. Similarly, other constituent companies, like Bharat Electronics Ltd. (BEL), Cochin Shipyard Ltd., Mazagon Dock Shipbuilders Ltd., etc., are sitting on huge order books.

In the last few years, the government has been increasing budgetary allocations for strengthening India’s Defence Forces. Here is a look at the defence budgetary allocations for the last few years.

The above table shows how the budgetary allocations made for defence have been increasing in the last five years. These huge allocations have resulted in huge orders for various defence companies. In future also, the defence companies are expected to bag huge orders from the defence forces.

So, the companies that are a part of the Nifty India Defence Index have good revenue visibility for the next few years. However, the financial performance will depend on the timely execution of the order book. Also, the valuations of these companies are expensive. Growth companies get higher valuations during a bull run like the one we are currently in. However, in the event of a correction, these companies usually fall more than others.

Should you invest in the Nifty India Defence Index?

The two AMCs, Motilal Oswal and Aditya Birla AMC, offer index funds on the Nifty India Defence Index. To decide whether to invest in the Nifty India Defence Index funds, you should work with a qualified and experienced financial advisor. They can help you list your financial goals and make a goal plan along with appropriate asset allocation to achieve the goals. For the equity component of your portfolio, you should first focus on building a portfolio of diversified equity mutual fund schemes.

Once you do that, you may allocate a small percentage of your equity portfolio to sectoral, thematic, smart-beta funds. The Nifty India Defence Index funds come within the thematic category. These funds carry relatively higher risks than diversified equity funds and are meant for investors with a high-risk appetite. Hence, work with a good financial advisor who can make a customised financial plan for you and recommend mutual fund schemes that suit your risk profile.

Gopal Gidwani is a freelance personal finance content writer with 15+ years of experience. He can be reached at LinkedIn.