The defense sector has seen an impressive rise over the past year, becoming one of the most profitable areas for investors. However, in the last month, the sector has shown some signs of slowing down, causing concerns about whether the boom will continue or whether the momentum is fading. The launch of multiple mutual funds targeting this sector has fueled excitement, but recent performance dips have raised questions for many investors. Let’s explore what’s driving the defense sector and what experts are advising going forward.
Strong Year for Defense but Recent Dip Raises Questions
Over the past 12 months, the defense sector has posted strong returns, making it one of the top performers in the market. However, short-term performance has seen a decline, with a 5.19% drop in the last month. This has made investors nervous, especially those who entered during the peak.
On the institutional level, several new passive funds betting on this sector have emerged, including Motilal Oswal Nifty India Defense ETF, Motilal Oswal Nifty India Defense Index Fund, and Aditya Birla Sun Life Nifty India Defense Index Fund. These were launched in August 2024. Currently, HDFC Defense Fund is the only active fund in the market. Additionally, the NFO (New Fund Offering) for Grow Nifty India Defense ETF and FOF (Fund of Fund) is now open and will close on October 4th.
The question investors are now asking is whether this sector will continue its upward trajectory or if the recent dip is a sign of things to come.
What Makes the Defense Sector Attractive?
There are several factors driving optimism in the defense sector. According to Grow Mutual Fund, the Indian defense industry’s production is expected to grow significantly by 2029, with a target of Rs 3 lakh crore (3 trillion rupees). Between FY2024 and FY2032, investments worth $13.8 billion could flow into the sector. Additionally, the government has set a goal of achieving Rs 50,000 crore in defense exports by FY2029.
The sector is also benefiting from India’s push for self-reliance, known as the ‘Atmanirbhar Bharat’ initiative. The government has allocated Rs 6.22 lakh crore to the defense budget for FY2024-25, which has boosted confidence in continued growth. Varun Gupta, CEO of Grow Mutual Fund, pointed out that companies in the defense sector have seen steady revenue growth of 9% since 2018, while profits have jumped by 20%. Previously, there were only six listed defense companies, but that number has now increased to more than 20.
Why Investors Should Be Cautious
While the defense sector’s growth story seems strong, there are some risks investors need to consider. Over the past year, the Nifty India Defense Index has surged by 106.18%, but in a short span, the index’s valuation has risen dramatically. In 2022, the index’s price-to-earnings (P/E) ratio was around 22, but it shot up to 70 before cooling down to 57 at the end of August.
Another issue is the concentration of companies in the index. Bharat Electronics, Hindustan Aeronautics, and Solar Industries dominate the index, accounting for about 55% of its total weightage. This lack of diversification increases the risk for investors, as the performance of a few companies heavily influences the overall sector.
Vikas Gupta, CEO of Omniscience Capital, advises looking beyond conventional defense companies to find undervalued opportunities. He believes expanding the investment horizon to non-conventional proxy defense companies could provide better long-term prospects.
What Should Investors Do?
Experts caution investors to approach the defense sector carefully, given its volatility and high valuations. While the long-term outlook seems promising, it’s essential to understand the risks and know when to enter and exit. A common recommendation is to avoid allocating more than 5-10% of your investment portfolio to any single sector, including defense.
For investors with a lower risk tolerance, experts suggest considering more diversified options like flexicap or multicap funds, which spread investments across different sectors and reduce risk. On the other hand, investors with a higher risk appetite might find opportunities in the defense sector, provided they are willing to ride out short-term volatility.
Ultimately, the defense sector is growing rapidly, and government support will likely continue to fuel this growth. However, the sector’s sharp rise in valuation, coupled with its dependence on a few key companies, means that caution is necessary. Investors should weigh their risk tolerance carefully and consider diversified strategies when making decisions in this space.
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