5 Things to Know Before Investing in a Defense Mutual Fund

India’s defense sector has seen a steady rise, driven by local manufacturing, government incentives, and rising geopolitical awareness. With growing investor interest in defense-linked companies, mutual funds focused on this space are now gaining popularity.

But unlike diversified equity funds, sectoral funds carry unique risks and demands. Before placing your money in one, it’s important to understand how this niche works.

In this article, we’ll walk you through five critical things you should know before investing in a defense mutual fund in India.

Defense Mutual Funds: 5 Key Insights

Before you put your investments into defence mutual funds, here are 5 important things you should know to make a smart decision.

1. Understand the Thematic Nature & Limited Diversification

Defence mutual funds are thematic, meaning they focus on one theme: defence, rather than investing across many industries.

They must invest at least 80% in defence-related stocks. This narrow focus leads to limited diversification, so if the defence sector underperforms due to budget cuts, geopolitical issues, or contract delays, the entire fund can closely mirror that downturn.

In simple terms, high focus = high potential, but also higher risk.

2. Assess Recent Performance & Valuation Levels

In the past three months, defence-themed mutual funds in India surged nearly 60%, with an average gain of about 57.7%, driven by strong earnings, record defence budgets, and geopolitical triggers like Operation Sindoor.

However, valuations soared sharply. The Nifty Defence index trades at around 52× P/E, more than double the broader market, indicating prices may already reflect high expectations.

Experts warn that current gains are momentum-driven and suggest cautious entry, ideally via SIPs rather than lump sum investments.

3. Know the Key Funds and Their Structure

In India, there are two main types of defence mutual funds:

• Active Funds: These funds, such as HDFC Defence Fund,pick about 20–25 companies, including HAL, Solar Industries, Bharat Forge, and Bharat Dynamics.
• Index/passive Funds: They simply replicate the NSE’s sector index. They cover 18–20 stocks (for example, Bharat Electronics, HAL, Solar Industries) with a lower expense ratio (0.4–1.1 %) 

Active funds aim to outperform via smart selection. Passive ones offer steady market returns at a lower cost.

4. Evaluate Risks Tied to Policy, Contracts & Geopolitics

Defence mutual funds face risks from changing government policies, defence contracts, and international tensions.

Delays or cancellations in defence procurement and budget cuts can hurt company earnings. Shifts in procurement rules and offset policies may disrupt projects.

Also, geopolitical events like border tensions or conflicts often cause sharp swings in stock prices, with quick rallies followed by sudden drops. Investors should be ready for this unpredictability and treat these funds as volatile.

5. Clarify Your Objective, Horizon & Allocation Strategy

Investing in a defence mutual fund calls for clear goals, a timeline, and limits. First, decide why you’re investing.

Are you chasing high growth or diversifying? Then set a horizon of at least five to seven years to ride out industry ups and downs. Don’t pour too much in; keep it modest, around 5 to 10% of your equity portfolio.

Finally, choose a method. A systematic SIP helps spread risk, while small lump sums during dips suit tactical investing.

Conclusion

Defence mutual funds can give attractive returns, but also come with high risk. Before you invest, make sure you understand the theme, recent performance, and market risks. These funds work best as a small part of your total portfolio. If you are patient and think long term, they may add value over time.