The real arsenal in defence thematic funds
India’s defence sector has caught the imagination of retail investors, and mutual fund houses have responded swiftly. Today, there are six thematic schemes that promise to give investors exposure to the country’s military-industrial growth story. Of these, five are passively managed, all tracking the Nifty India Defence Index. Only one, the HDFC Defence Fund takes an active approach.
With geopolitical tensions making headlines and the government’s focus on self-reliance in defence manufacturing, the story writes itself. After “Operation Sindoor” sent a clear message across the border, investors got the message too: defence is hot again. Add a ₹40,000 crore emergency procurement push and a few strong earnings from top players, and you’ve got a rally that looks locked and loaded. Fund returns mirror this momentum (see table). But as always, when the market salutes too quickly, caution is the better drill.
Passive herd
The passive funds are clones. Whether it’s Motilal Oswal’s Nifty India Defence Index Fund and ETF, Aditya Birla Sun Life’s version, or Groww’s ETF and FoF, they all mirror the same benchmark i.e. the 18-stock Nifty India Defence Index. They are packed with the same set of stocks. Hindustan Aeronautics, Bharat Electronics, Solar Industries, Mazagon Dock, and Bharat Dynamics dominate the top holdings, together forming nearly 70 per cent of the portfolio. There is nothing wrong with this replication. It is by design.
Expense ratios are however a key differentiator when compared with active fund. Passive funds come cheap, typically charging 0.30 per cent to 0.40 per cent annually. In contrast, the actively-managed HDFC Defence Fund has an expense ratio of around 0.70 per cent.
Investors choosing the ETF route should also watch out for liquidity gaps in low-volume ETFs, where the buy-sell spread may eat into returns.
Lone active voice
That leaves us with the only actively managed fund in this category — the 22-stock HDFC Defence Fund. It does offer some variety. While HAL, BEL, and Solar Industries still form the top trio, the rest of the portfolio takes a more scattered approach.
You see bets on lesser-known players: Premier Explosives, Cyient DLM, Avalon Tech, Power Mech Projects, Techno Electric, The Anup Engineering. There are even slivers of exposure to Interglobe Aviation and Adani Energy. The presence of such names suggests that the fund manager is trying to cast a wider net across the defence value chain, beyond the usual PSU monoliths.
Small-cap weight is much higher here compared to passives. About 26.5 per cent of the fund is in small-cap stocks, which contrasts with the more mid to large-cap orientation of the index-tracking funds. In terms of spread, the active fund leans more towards small and giant-caps, whereas the passive index funds tilt heavily towards large and mid-cap exposure. This could provide differentiated alpha in the long run, or magnify volatility.
What defence stocks do
HAL makes combat aircraft, trainers, helicopters, and avionics. BEL provides radar, communication, and electronic warfare systems. Solar Industries manufactures strategic explosives. Mazagon Dock builds warships and submarines, while Cochin Shipyard handles naval and commercial vessels. Bharat Dynamics produces guided missiles and torpedoes. Astra Microwave supplies radar electronics and subsystems for defence and space. MTAR Technologies makes precision components for missiles, nuclear and space programmes. Zen Technologies develops simulators and counter-drone solutions for defence and homeland security.
So yes, the listed space gives access to companies engaged in real production from strategic hardware to enabling subsystems. But the big-ticket integrators such as Tata Advanced Systems, Adani Defence, and private firms executing DRDO transfers remain out of reach for direct retail investment.
Valuations and volatility
Valuation trends merit closer scrutiny. Much of the recent rally in defence stocks appears to stem from sentiment and P/E expansion, not necessarily earnings growth. Over the past five years, Bharat Dynamics and Cochin Shipyard have each seen their stock prices jump over 13x, while their earnings have grown just 1.2x and 1.4x, respectively.
Many companies are trading at elevated multiples. Bharat Dynamics is at 100 times earnings, MTAR Tech at 102, and Paras Defence at 88. These valuations reflect optimism about future growth, though they may be running ahead of actual fundamentals.
And perfection is a stretch. While many firms still depend heavily on the government as their primary client, the landscape is evolving. India’s defence exports surged to a record high of ₹23,622 crore in FY2024-25, a 12 per cent increase over the previous year, with private players contributing over ₹15,000 crore. This rise in global demand means Indian defence firms are no longer entirely reliant on the Ministry of Defence; exports are now a meaningful channel.
That said, for many of the fund-heavy holdings, the government remains the anchor client. Orders are still lumpy, irregular, and prone to budget cycles and policy delays. This means order books for smaller firms can suddenly fall and defence revenue can show one-off plunge in a quarter.
Our take
India’s defence funds are selling a story of military resurgence, self-reliance, and national ambition. It’s a compelling narrative. But the listed ecosystem currently offers only a partial view.
Passive funds are essentially index wrappers. They provide market beta, not selective exposure. The active HDFC fund attempts broader discovery but remains tethered to many of the same names.
Investors are buying into the promise of an industrial defence cycle. What they’re getting is exposure to the key enablers of that journey, often at premium valuations.
Published on May 24, 2025