The war profiteering is making a big comeback on the global landscape. With ever-increasing national budgets for defence in many parts of the world, defence stocks are in the limelight.

According to Stockholm International Peace Research Institute, global defence spending surpassed USD 2 trillion in 2021 for the first time ever. According to the Ministry of Defence, China and the U.S. together accounted for a 52% share of the world’s defence expenditure in 2021. India was a distant third.

While the U.S. and China spent USD 801 billion and USD 293 billion respectively, India allocated USD 76.6 billion on defence.

That said, India is bound to find itself at the epicentre of activities over the next decade or so. Here’s why…

India is not just the fastest growing major economy; it is home to the world’s second-largest armed force. It’s noteworthy that India is planning to modernise its armed forces, as well as become self-reliant or Atmanirbar in defence equipment manufacturing, besides eyeing export opportunities.

Prime Minister, Narendra Modi addressing a seminar, ‘Swavlamban’, organised by the Naval Innovation and Indigenisation Organisation (NIIO) in July 2022 said, the goal of self-reliance in the defence forces was very important for the India of the 21st century. He further stated that a self-reliant defence system is critical for the economy plus from a strategic point of view.

Perhaps these comments by Prime Minister were in view of the unending war between Russia and Ukraine. Russia’s invasion of Ukraine highlighted the importance of defence preparedness even for smaller nations. Plus, given the escalating tensions between India and China over the border dispute at the Line of Actual Control (LAC).

China’s recent war drills after some high-profile U.S. lawmakers visited Taiwan reinforced how critical defence spending has become for any nation.

As you might know, Philippines recently purchased India’s supersonic cruise missile BrahMos (manufactured BrahMos Aerospace Limited). Malaysia too has shortlisted India’s lightweight multirole combat aircraft, Tejas (manufactured by Hindustan Aeronautics Limited). And after this, the government also informed that the U.S. and Australia are also among the countries that have shown interest in the multirole combat aircraft, Tejas.

Needless to say, companies that have been the beneficiaries of India’s thriving defence sector, especially the missile programme and aerospace sector, have done exceptionally well over the past few months.

We thought it would be interesting to analyse how mutual funds have reacted to the recent developments and whether they have taken advantage of massive rallies in defence stocks.

Table 1: How bullish mutual funds have been on defence companies?

Company Mutual Fund Holding (%) as of 30th June 2022 % Change in Weight since 31st March Price as of 30th June 2022 Price as of 31st March 2022 CMP* % Change in Price since March 2022
MTAR Technologies 23.55 2.37 1,270 1,748 1,621 -7.3
Bharat Electronics 22.42 0.68 234 211 320 51.7
Bharat Forge 18.9 1.26 652 702 752 7.1
BEML 16.64 -0.53 1,254 1,817 1,876 3.2
Mishra Dhatu 12.65 -0.17 164 165 198 19.6
GRSE 9.09 -1.58 224 226 313 38.1
Bharat Dynamics 8.27 -0.73 680 547 831 52.0
Hindustan Aeronautics 7.37 -0.46 1,769 1,487 2,300 54.7
Cochin Shipyard 2.34 0.06 311 294 379 29.0
Mazagon Dock shipbuilders 0.95 -0.01 246 240 402 67.9
Astra Microwave 0.16 -0.13 197 225 350 55.9

#On a YTD basis markets were at the lowest point in June 2022. This is as per the stock exchange data
* Current Market Price (CMP) as of 1st September 2022
(Source: BSE, PersonalFN Research)

As seen in Table 1, pure defence plays such as Hindustan Aeronautics, Bharat Dynamics, Bharat Electronics, Mazagon Dock shipbuilders and Cochin Shipyard amongst others have rallied since March 2022. In many of these stocks, mutual funds trimmed their position as of June 2022.

But in companies such as MTAR Technologies, Bharat Forge, and Bharat Electronics, certain mutual funds schemes noticeably increased their exposure.

We considered 206 diversified mutual fund schemes for deeper analysis of which 131 schemes had invested in at least one defence stock as of 31st July 2022. Ten schemes had an exposure of 5% or more, 18 had an exposure of less than 1%, and 78 others had an exposure between 1% and 2%. The average defence sector exposure of diversified equity funds was 2.4% while the average single stock exposure was 1.5%. The maximum single stock exposure was 4.6%.

Interestingly, a majority of schemes having more than 5% exposure to defence companies were among, Value Funds, Midcap Funds, and Focused Funds.

At the fund house level, HDFC Mutual Fund, Invesco Mutual Fund, Kotak Mahindra Mutual Fund and DSP Mutual Fund have been betting aggressively on India’s defence sector.

Here are five diversified equity funds betting on defence stocks…

Table 2: Top 5 diversified equity funds with high exposure to defence stocks

Portfolio data as of 31st July 2022
(Source: ACE MF, PersonalFN Research)

Besides some of the recently launched mutual fund schemes, also held high exposure to defence stocks. For instance, DSP Value Fund — launched in December 2020 — has 5.9% exposure to the defence sector as per its portfolio data as of 31st July 2022.

#1: HDFC Mid-Cap Opportunities Fund

Launched on 25th June 2007, HDFC Mid-Cap Opportunities Fund aims to provide long-term capital appreciation/income by investing predominantly in midcap companies.

As of 31st July 2022, HDFC Mid-cap Opportunities Fund held 63 stocks in its portfolio while its weightage to equity assets was 97.5%. The remaining assets were the cash and equivalent assets to manage the liquidity needs. The mid and small-cap companies accounted for 64.9% and 19.9% of the portfolio respectively, while large-caps 12.7% as per the portfolio as of 31st July 2022.

Table 3: Top defence stock holdings of HDFC Mid-Cap Opportunities Fund

Stocks % of Assets
Bharat Electronics Ltd. 4.6
Hindustan Aeronautics Ltd. 3.9

Data as of 31st July 2022
(Source: ACE MF, PersonalFN Research)

Among the defence stocks, Bharat Electronics and Hindustan Aeronautics featured in the top-5 stocks of the fund as of 31st July 2022. However, the fund has been offloading some portion of its holdings in defence stocks on rallies, possibly to keep a single stock exposure below 5%.

#2: Mirae Asset Midcap Fund

Launched on 29th July 2019, the fund has the investment objective of providing long-term capital appreciation from a portfolio investing predominantly in Indian equity and equity-related securities of midcap companies. From time to time, the fund manager may also participate in other Indian equities and equity-related securities for optimal portfolio construction.

As of 31st July 2022, Mirae Asset Midcap Fund held 55 stocks in its portfolio. The fund remained almost fully invested with equity allocation weighing 98.9% in the portfolio. Other than midcaps, the fund invested 16.1% and 17.1% of its total assets in large-cap and small-cap companies, respectively, as per its portfolio as of 31st July 2022.

Table 4: Top defence stock holdings of Mirae Asset Midcap Fund

Stocks % of Assets
Bharat Forge Ltd. 3.5
Bharat Electronics Ltd. 1.4
Hindustan Aeronautics Ltd. 0.9

Data as of 31st July 2022
(Source: ACE MF, PersonalFN Research)

Mirae Asset Midcap Fund has taken a bullish stance on Bharat Forge and has been consistently increasing the stake in the company for the past 6 months. Currently, Bharat Forge constitutes a part of the top-5 holdings of the fund.

On the other hand, the fund has been booking profit on rallies in Bharat Electronics and Hindustan Aeronautics.

#3: HDFC Focused 30 Fund

Launched on 17th September 2004, HDFC Focused 30 Fund aims to generate long-term capital appreciation/income by investing in equity & equity-related instruments of up to 30 companies.

As of 31st July 2022, the fund held 92.5% of its overall portfolio in equities. The total stock count of the portfolio was 31.

Table 5: Top defence stock holdings of HDFC Focused 30 Fund

Stocks % of Assets
Hindustan Aeronautics Ltd. 4.2
Bharat Dynamics Ltd. 2.3
GRSE Ltd. 0.8

Data as of 31st July 2022
(Source: ACE MF, PersonalFN Research)

While following a focused approach, HDFC Focused 30 Fund invested 74.2% of its total assets in large-caps and the remaining in mid-cap and small-cap companies. Cash and cash equivalents assets accounted for 7.5% of its overall portfolio.

The fund has been adding Hindustan Aeronautics to its portfolio systematically. The fund’s total holdings in the company increased to 3.7 lakh shares as of 31st July 2022 from 2.25 lakh shares at the end of 28th February 2022.

On the other hand, HDFC Focused 30 Fund has pared its exposure to Bharat Dynamics and GRSE over the same time period. It completely got rid of MTAR Technologies in June 2022.

#4: Kotak Flexicap Fund

Launched on 11th September 2009, Kotak Flexicap Fund aims to generate long-term capital appreciation from a portfolio of equity and equity-related securities, generally focused on a few selected sectors.

As on 31st July 2022, the equity component accounted for 97.2% of the portfolio while the remaining 2.8% of assets were parked in cash and cash equivalent.

The portfolio comprised of 49 stocks, wherein the large-caps made up 73.3% of the portfolio while mid and small-caps accounted for 22.4% and 1.4% respectively.

Table 6: Top defence stock holdings of Kotak Flexicap Fund

Stocks % of Assets
Bharat Electronics Ltd. 3.8
Bharat Forge Ltd. 1.1
BEML Ltd. 0.3

Data as of 31st July 2022
(Source: ACE MF, PersonalFN Research)

[Download and read PersonalFN’s Ultimate Guide to Invest in the Best Flexi Cap Funds in 2022]

The fund has been accumulating Bharat Forge over the last 6 months. In February 2022, the Kotak Flexicap Fund owned 14 lakh shares of the company, and the count now has jumped to 56.5 lakh by July 2022.

Bharat Electronics, its top defence pick found a place in its top-10 holdings as of 31st July 2022. The fund has kept its shareholding unchanged in Bharat Electronics and BEML over the past 6 months.

#5 Sundaram Focused Fund

Launched on 11th November 2005, Sundaram Focused Fund aims to provide capital appreciation and/or dividend distribution by investing in companies across market capitalization.

As of 31st July 2022, the fund held a compact portfolio of 30 stocks with a total weight of equity assets to the tune of 92.3%. The balance was cash and cash equivalent assets.

Large-caps were the fund’s core holdings with a weightage of 62.8% of the portfolio and the remaining equity component comprised of mid and small-cap companies.

Table 7: Top defence stock holdings of Sundaram Focused Fund

Stocks % of Assets
Bharat Electronics Ltd. 2.9
BEML Ltd. 2.7

Data as of 31st July 2022
(Source: ACE MF, PersonalFN Research)

Like a few other funds, Bharat Electronics has been Sundaram Focused Fund’s top defence pick as of 31st July 2022.

Further, the fund has been accumulating BEML over the past 6 months, while has kept its shareholding unchanged in Bharat Electronics.

How have mutual fund schemes betting on the defence sector performed?

Schemes with high exposure to defence stocks have done well vis-a-vis broader market indices on risk-adjusted returns.

Table 8: Performance of mutual fund schemes betting on defence stocks

Scheme Name Returns Absolute (%) CAGR Returns (%) Risk-Ratios
6 Months 1 Year 2 Years 3 Years 5 Years 7 Years SD Annualised Sharpe
Mirae Asset Midcap Fund 10.6 11.6 38.1 31.7 24.56 0.31
HDFC Mid-Cap Opportunities Fund 12.5 14.1 33.1 26.5 14.1 15.7 24.34 0.26
HDFC Focused 30 Fund 15.8 24.6 35.5 22.8 11.7 12.9 24.60 0.21
Sundaram Focused Fund 4.6 4.6 27.2 22.8 14.6 14.4 21.04 0.24
Kotak Flexicap Fund 8.0 5.3 23.9 17.7 12.2 14.2 22.63 0.18
NIFTY 100 – TRI 7.4 7.0 25.4 18.9 13.4 13.6 22.61 0.19
NIFTY 500 – TRI 8.0 7.9 27.5 20.8 13.4 14.0 23.18 0.21
Nifty Midcap 150 – TRI 12.3 12.6 35.2 28.7 15.0 16.8 25.95 0.26
Nifty Smallcap 250 – TRI 5.1 6.7 36.6 28.8 9.9 13.0 30.56 0.24

Data as of 30th August 2022
Direct Plan and Growth Option considered.
Past performance is not indicative of future returns.
(Source: ACE MF, PersonalFN Research)

Mirae Asset Midcap Fund has delivered a handsome CAGR of 31.7% over a period of 3 years by taking calculated risks and has rewarded its investors handsomely on a risk-adjusted basis.

HDFC Mid-Cap Opportunities Fund and HDFC Focused 30 Fund also have adequately compensated their investors for the risk taken better than some of their peers.

Similarly, Sundaram Focused Fund — one of the top performers in its category — has clocked an appealing CAGR of 22.8% while managing the risk well.

The Outlook for the Defence sector in India

Defence companies in India are possibly in a multi-year up-cycle with Defence Production and Export Promotion Policy 2020 (DPEPP 2020) guiding for more than doubling the production and procurement targets over the next few years. DPEPP 2020 has set a target of achieving Rs 1.75 lakh crore of production and Rs 35,000 crore of exports by 2025. According to DPEPP, India’s defence sector had an estimated turnover of Rs 80,000 crore in 2020.

To promote domestic manufacturing of defence equipment, the Department of Military Affairs has notified a total of 310 items by releasing three Positive Indigenisation Lists (PILs) between August 2020 and now.

Moreover, the Department of Defence Production has published two PILs notifying a total of 2,607 items. The implementation is indicated to happen in a piecemeal manner between 2022 and 2027.

For all the aforementioned reasons, India’s defence sector might remain one of the favourites of investors including that of mutual funds.

This article first appeared on PersonalFN here

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