5 Mutual Funds with High Exposure to Defence Stocks

Editor's note: Public Sector Undertakings (PSUs), lost their appeal over the last decade. But the market spotlight has shifted back on them of late. In fact, in some cases, PSU companies are leading the sectoral rallies. A case in point is India's defence sector.

In March 2022, we wrote an article highlighting 5 mutual funds having high exposure to defence stocks. The last six months have been quite eventful for the defence sector companies, not just in India but all over the globe.

We thought of reviewing the article to see how mutual funds have been reacting to the recent rally in defence stocks and prominent sector-specific developments.

Update

On 2 September 2022, India joined an elite club of countries capable of building aircraft carriers indigenously. In a memorable event conducted at Cochin Shipyard, the Prime Minister of India dedicated INS Vikrant to the service of the nation.

The timing of this watershed moment demonstrating India's defence sector capabilities couldn't have been any better.

Various countries across the world are willing to spend more on defence preparedness given the ongoing geopolitical uncertainties. In 2021, global defence spending exceeded US$ 2 tn for the first time.

The journey of INS Vikrant is quintessential of complex and large-scale defence manufacturing projects. You will be surprised to know the Government of India (GoI) issued a letter of intent to build an indigenous aircraft carrier in 2004. However, the construction work began only in 2007.

Nearly 550 companies concurrently worked along with Cochin Shipyard painstakingly for the last 15 years on INS Vikrant. The cost of INS Vikrant has been Rs 20,000 crore.

Such multi-year-high-value defence projects have offered rich learning experiences not only to the government but also to various defence sector companies. Similar projects in future might save some time since the foundational work is already in place.

What's true in the case of manufacturing indigenous aircraft carriers also extends to home-grown submarines and destroyers, hypersonic missiles, and lightweight fighter aircrafts.

A slew of reforms and incentives under the Production Linked-Incentive (PLI) scheme have brightened the prospects of India's defence sector. Increased defence spending has offered a long runway of growth to defence companies.

India plans to modernise its armed forces and become self-reliant or Atmanirbar in defence equipment manufacturing, besides eyeing export opportunities.

This is why investors have lapped up defence stocks over the past 6-8 months sending many of them to their multi-year/lifetime highs.

How have mutual funds reacted to these developments?

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Update

According to the shareholding pattern declared by listed defence sector companies at the end of Q1FY23, MTAR Technologies, Bharat Electronics, Bharat Forge, BEML, and Mishra Dhatu are the top 5 favourites of the mutual fund industry.

Table 1: Which are the Favourite Defence Stocks of Mutual Funds?

Company	Mutual Fund Holding (%) as of 30 June 2022	% Change in weight since 31 March 2022	Price as on 30 June 2022	Price as on 31 March 2022	CMP*	% Change in Price since March 2022
MTAR Technologies	23.55	2.37	1,270	1,748	1,596	-8.7
Bharat Electronics	22.42	0.68	234	211	328	55.6
Bharat Forge	18.9	1.26	652	702	788	12.3
BEML	16.64	-0.53	1,254	1,817	1,630	-10.3
Mishra Dhatu	12.65	-0.17	164	165	204	23.1
Bharat Dynamics	8.27	-0.73	680	547	811	48.4
Hindustan Aeronautics	7.37	-0.46	1,769	1,487	2,432	63.5
Cochin Shipyard	2.34	0.06	311	294	383	30.3
Mazagon Dock shipbuilders	0.95	-0.01	246	240	421	75.8
Astra Microwave	0.16	-0.13	197	225	329	46.5

*CMP as on 9 September 2022
Data as of Q1FY23 as released by bseindia.com
(Data Source: BSE, PersonalFN Research)

As exhibited in table 1, a number of defence stocks have rallied since March 2022. In some cases, the increase in holdings of mutual funds is a result of market movements.

LIC holds a large stake in defence PSUs. However it seems to have taken a conscious approach after the massive rally in defence stocks over the last six months.

Between Q3FY22 and Q1FY23, LIC trimmed its stake in Hindustan Aeronautics to 7.72% from 11.65%, and in Bharat Dynamics from 8% to 5.21%.

On the other hand,LIC marginally increased its stake in Bharat Electronics from 1.28% in Q3FY22 to 1.31% in Q1FY23.

We also analysed the portfolios of all diversified equity mutual fund schemes to see how many of them are betting big on the defence sector.

Update

Mutual funds benefitted from the rally in defence stocks, but with it, reduced the exposure in the overall shareholding of a number of defence companies. In other words, they booked profits.

We found that, as compared to 108 in February 2022, 133 diversified equity funds held at least one defence stock in their portfolios in August 2022. However, only 11 of them had an exposure of more than 5%. The portfolios of 63 schemes had an exposure of 2% or less.

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

The average single stock exposure was 1.6% with a maximum exposure of 4.9%. This goes to show that most of the diversified equity mutual fund schemes have been holding defence stocks as part of their satellite holdings, hoping to cash in on the potential opportunities in the sector.

The likely reason for Value Funds along with some Dividend Yield Funds having high exposure to defence stocks could be the dominance of PSUs in the defence sector.

At a fund house level, HDFC Mutual Fund, DSP Mutual Fund, and Invesco Mutual Fund held the highest exposure to defence stocks, going by the portfolio holdings of diversified schemes.

Update

Table 2: Top 5 Diversified Equity Funds with High Exposure to Defence Stocks

Scheme Name	Exposure as a % of the Portfolio as of 28 February 2022 (%)	Exposure as a % of the Portfolio as of 31 August 2022 (%)
HDFC Mid-Cap Opportunities Fund	7.2	8.9
IDBI Dividend Yield Fund	5.4	6.8
HDFC Focused 30 Fund	5.8	6.1
Mirae Asset Midcap Fund	7	5
Aditya Birla SL Pure Value Fund	6.4	1.7

(Source: ACE MF, PersonalFN Research)

Here is a review of 5 mutual fund schemes that had high exposure to defence stocks in February 2022.

Going by portfolio composition in August 2022 vis-a-vis that in February 2022, it appears some of them have taken a cautious approach during the ongoing rally in defence stocks.

On the other hand, certain mutual fund schemes that had a low to moderate exposure to the defence sector took an opportunistic approach by betting aggressively of late.

For example, Mahindra Manulife Top 250 Nivesh Yojana had just 3% exposure to defence companies in February 2022 which went up to 7.2% by the end of August 2022.

Similarly, Sundaram Focused Fund, Invesco India Midcap Fund and Kotak Flexicap Fund are a few other funds that have increased their bets on defence companies.

#1: HDFC Mid-Cap Opportunities Fund

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

Update

As of 31 August 2022, the weightage of equity assets in its portfolio is 97.8% with a total of 63 stocks. The remaining was in the cash and equivalents to manage liquidity needs.

Table 3: Top Defence Stock Holdings of HDFC Mid-Cap Opportunities Fund

Stocks	% of Assets
Bharat Electronics Ltd.	4.7
Hindustan Aeronautics Ltd.	4.2

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

Bharat Electronics and Hindustan Aeronautics found a place in the top 5 picks of the fund as of 31 August 2022

The fund has been pruning its exposure to these companies depending on the market movement.

For instance, between March 2022 and June 2022, it took advantage of the market weakness and accumulated Hindustan Aeronautics. Its holding jumped from 56 lakh shares in February 2022 to 74.2 lakh shares in June 2022.

However, now that the stock has jumped around 63% from its June lows, the fund seems to be booking profits. As on 31 August 2022, HDFC Mid-Cap Opportunities Fund held 63.1 lakh shares of Hindustan Aeronautics.

It's holding in Bharat Electronics remained unchanged between February 2022 and June 2022. But here too, the fund opted to adjust its exposure with rising stock prices.

#2: Mirae Asset Midcap Fund

Launched on 29 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.

Update

As of 31 August 2022, Mirae Asset Midcap Fund holds 55 stocks in its portfolio. The fund has remained almost fully invested with equity allocation weighting 98.4% in the portfolio.

Table 4: Top Defence Stock Holdings of Mirae Asset Midcap Fund

Stocks	% of Assets
Bharat Forge Ltd.	3.5
Bharat Electronics Ltd.	1.5

Data as of 31 August 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 at regular intervals in Bharat Electronics. That said, it completely offloaded its stake in Hindustan Aeronautics in July 2022.

#3: Aditya Birla Sun Life Pure Value Fund

Launched on 27 March 2008, Aditya Birla Sun Life Pure Value Fund's investment objective is to generate consistent long-term capital appreciation by investing predominantly in equity and equity-related securities by following a value investing strategy.

Update

As of 31 August 2022, Aditya Birla Sun Life Pure Value Fund holds 69 stocks in its equity portfolio. Investment of the fund in equity assets accounted for 94.4% of the portfolio. The remaining 5.6% of its portfolio is in cash and equivalent assets.

Table 5: Top Defence Stock Holdings of Aditya Birla Sun Life Pure Value Fund

Stocks	% of Assets
Hindustan Aeronautics Ltd.	0.9
MTAR Technologies Ltd.	0.8

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

The fund got rid of some leading defence companies such as Bharat Electronics, Bharat Forge and Bharat Dynamics in March and April 2022.

Moreover, the fund has substantially reduced its exposure to Hindustan Aeronautics and MTAR Technologies over the last 6 months.

From 6.5 lakh shares in February 2022, the fund's holdings in Hindustan Aeronautics reduced to 1.65 lakh shares. The fund offloaded nearly 47,000 shares of MTAR Technologies between February 2022 and August 2022.

#4: HDFC Focused 30 Fund

Launched on 17 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.

Update

As of 31 August 2022, the fund held 89.7% of its overall portfolio in equities with a total stock count of the portfolio was 30. Cash and equivalent assets accounted for the rest.

Table 5: Top Defence Stock Holdings of HDFC Focused 30 Fund

Stocks	% of Assets
Hindustan Aeronautics Ltd.	4.1
Bharat Dynamics Ltd.	2.0

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

HDFC Focused 30 Fund exited MTAR Technologies completely in May 2022. Itincreased its exposure to Hindustan Aeronautics between March and June, keeping it constant thereafter. Similarly, its holding has been constant in Bharat Dynamics over the past 5 months.

#5: IDBI Dividend Yield Fund

IDBI Dividend Yield Fund was launched on 21 December 2018. The fund's investment objective is to provide long-term capital appreciation and/or dividend distribution by investing predominantly in dividend-yielding equity and equity-related instruments.

Update

As of 31 August 2022, the fund held 98.9% of its overall portfolio in equities with a total stock count of 39. The cash and cash equivalents to manage the liquidity needs was 1.1% of the overall portfolio.

Table 5: Top Defence Stock Holdings of IDBI Dividend Yield Fund

Stocks	% of Assets
Bharat Electronics Ltd.	3.2
BEML Ltd.	2.0
Bharat Forge Ltd.	1.6

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

The stake of IDBI Dividend Yield Fund in Bharat Electronics, BEML, and Bharat Forge has remained unchanged for the past 6 months, reflecting the fund's buy-and-hold strategy.

Outlook for the Defence sector in India

Defence Production & Export Promotion Policy (DPEPP) 2020 envisions the Indian defence sector to achieve a dual objective of self-reliance and exports through Public Private Partnership (PPP).

Broadly, the goals of DPEPP 2020 are to...

• Develop a globally competitive defence industry catering across the value chain
• Promote import substitution by taking initiatives through domestic design and development
• Encourage R&D and IP ownership
• Achieve a turnover of US$ 25 bn in defence manufacturing and services which includes exports of US$ 5 bn by 2025.

The Indian government is likely to spend a massive US$ 130 bn over the next 7-8 years on the modernisation of the armed forces.

As part of that, Budget 2022-23 has allocated Rs 3.85 lakh crore to defence and 68% of capital procurements will be met through domestic supplies. This may give a big boost to the indigenisation of defence procurement.

Moreover, 25% of the defence R&D budget will be allocated to industry, start-ups, and academia. At present, 209 defence platforms and equipment are on the list of import embargos. The government is expected to release the third list of positive indigenisation soon.

Mutual funds are one of the best ways to benefit from India's growth story. Just ensure that you select the best and most suitable mutual fund schemes for your portfolio.

Disclaimer: This article has been authored by PersonalFN exclusively for Equitymaster.com. PersonalFN is a Mumbai-based Financial Planning and Mutual Fund research firm known for offering unbiased and honest opinions on investing.