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A surgical strike: HDFC MF launches defence-themed fund. Should you invest?

20 May , 2023   By : Debdeep Gupta

A surgical strike: HDFC MF launches defence-themed fund. Should you invest?

HDFC Mutual Fund has launched the New Fund Offering (NFO) of the first defence sector fund in India, the HDFC Defence Fund (HDF). The NFO opens on May 19, 2023. At a time when geopolitical tensions are rising in many parts of the world, the need to invest in defence capabilities is being increasingly felt. No wonder defence-focused businesses are in demand and a fund around it should hog some investor attention.

What is on offer?

HDF aims to invest a minimum of 80 per cent of the corpus in shares of defence and allied sector companies. Defence and allied sector stocks include (i) stocks forming part of certain eligible ‘basic industries’ based on AMFI Industry classification including aerospace and defence, explosives, shipbuilding and allied services, as amended from time to time; or (ii) Stocks from any other defence and allied sectors as per the benchmark’s criteria; or (iii) stocks present on SIDM (Society of Indian Defence Manufacturers) list; and which obtain at least 10 per cent of revenue from the defence segment.

The scheme will be managed by Abhishek Poddar and the performance of the scheme will be benchmarked against Nifty India Defence Index TRI.

The investment strategy of the fund will focus on “growth and quality at reasonable valuations” and the fund manager will invest in companies of all sizes.

What works?

With increased geopolitical tensions, many countries, including India, want to invest in their defence capabilities. The Indian government has been consistently reinforcing its commitment to modernise its defence forces with the introduction of state-of-the-art technology and armaments. Capital expenditure in defence is increasing as the government is batting for import substitution to become ‘AtmaNirbhar.’ Self-reliance calls for local manufacturing of arms and other supplies. There is an expectation that the uptrend in defence orders to local companies will continue. The government is also supportive of exports of arms to friendly countries.

“Export revenue has a relatively smaller contribution to the revenue pie. Overall, India accounts for barely 1-2 per cent of global arms exports, even after growth of 8 times in the last 8 years. However, focus on R&D and manufacturing can allow Indian companies to tap large export potential growing forward,” says Abhishek Poddar, Fund Manager –Equity, HDFC Asset Management Company.

With government backing for local manufacturing of arms and research in defence and allied activities, many new companies may want to expand aggressively.

“As many Indian companies invest in creating capabilities in defence manufacturing, there is an opportunity for long-term investors. Many new companies should get listed in the near future and with the government’s increased focus on self-reliance, stocks of the defence sector can be wealth creators,” says Deepak Chhabria, founder and managing director, of Axiom Financial Services.

What does not work?

“The defence sector is tightly regulated and the government procurement decides the business opportunities for the companies operating in this sector,” says Ravi Kumar TV, founder of Gaining Ground Investment Services.

Changes in government policies, defence expenditures and export regulations can be a risk for investors.

“Government is the key buyer, which does create a buyer concentration risk. However, the fact that defence forces are in constant need to upgrade and modernize the defence platforms due to technological advancement and product obsolescence, creates a stable demand with steady growth,” says Poddar. Also, Indian companies could tap vast export potential going forward, he adds.

As of now, there are not many listed companies in this sector and going forward, expansion of the listed universe is crucial for investors to diversify their portfolios. Also, the quality of companies getting listed needs to be watched.

In the year ended May 17, 2023, the Nifty India Defence Index rose 56 per cent to 2,410 points.

As on April 28, 2023, the benchmark had 13 constituents. Hindustan Aeronautics and Bharat Electronics each had almost 20 per cent allocation. Solar Industries, the third largest stock, has 18 per cent weight. The universe for HDF comprises 21 stocks and 80 per cent of the scheme money will have to be invested in some of these stocks.

What should you do?

“Do not invest in the defence sector fund looking at last year’s returns, if you do not have a long-term view,” says Kumar.

Being a sectoral fund, this cannot be your first investment in mutual funds. If you have seen a couple of market cycles and have a core portfolio in place, then you can consider some allocation to this fund provided you have a high-risk taking capacity.

Kumar recommends this offering only to mature investors as a small allocation in a satellite portfolio. Besides, the sector is dependent largely on government policies and how much it decides on the defence section, year after year. “Most small individual investors should get exposure to opportunities in the defence sector if they are attractive enough through diversified equity funds,” he adds.

A run-up in stock prices in the last year cannot be ignored. Even if you are very bullish on the sector, there is no need to jump in with all your money into the NFO. Chhabria says to invest gradually if you are keen to take exposure to the defence theme

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