Should you invest in the upcoming HDFC Defence Fund NFO?

HDFC Mutual fund will launch its new fund offering (NFO) of the proposed HDFC Defence Fund on 19th May 2023. Subscription to the NFO will close on 02nd June 2023 and once the allotment is completed, the fund will be available for NAV related sale and repurchase at NAV related prices. 

Highlights of the HDFC Defence Fund

Here are some of the stand out features of the proposed NFO of HDFC Defence Fund.

•    The fund will invest in defence and aerospace stocks as well as in allied sectors. It will benchmark to the NSE Nifty Defence Index and the list approved by the Society of Indian Defence Manufacturers (SIDM).

•    The fund will be managed by Abhishek Poddar, who has over 17 years of experience in this field. The focus of the fund will be rising defence spending, higher indigenization of Indian defence, R&D focus, and expansion of manufacturing capabilities.

•    The fund will follow at bottom up approach to investing with deep understanding of the defence ecosystem. More than 80% of the fund corpus will be invested in listed defence stocks that derive more than 10% of their revenues from defence.

•    The benchmark for the fund will be the Nifty India Defence Index on the NSE and it will be evaluated on TRI (total returns index). In TRI, the benchmark returns from dividends and capital gains are considered.

•    The total addressable market cap for defence stocks in India is ₹299,476 crore, which is roughly about $37 billion. While 60% of this universe is large cap stocks, 13% are mid-caps and 28% are small caps. PSUs account for 78% of the addressable defence market.

•    The Nifty India Defence Index has a beta of 0.94 and a P/E ratio of 26.8X. Defence EPS has grown at CAGR of 17.5% in the last 5 years, nearly 500 bps higher than the Nifty. Nifty India defence index delivered CAGR stock returns of 63.4% over last 3 years.

•    There will be no entry load on the fund but an exit load of 1% will be charged if the redemption happens within 1 year. The HDFC Defence Fund will offer regular and direct options as well as growth and IDCW sub-options.

Why is the defence story so attractive in India?

One of the big questions that arises is why is the defence story so attractive in the Indian context. There are several growth drivers for the Defence sector in India and here are some fundamental factors that support the defence story in India.
•    The global geopolitical turmoil is a key reason for the rise in defence expenditure. But the bigger trend is that there is indigenization happening, especially in India. Between 1991 and 2020, there was low defence spending due to a rather peaceful environment. With the Russian attacks on Ukraine and China baring its fangs, defence spending is bound to escalate as countries protect their interests.

•    In the last 27 years since 1995, the Indian defence spending as a share of GDP has been consistent around 2.5%. This lower than the 3.5% that the US spends but more than the 1.7% of GDP that China spends on defence. In absolute terms, India’s defence spending has risen from $10 billion in 1995 to $77 billion in 2021. Indian defence spending is still just a third of China in absolute terms and less than a tenth of the US.

•    One reason that has brought the Indian defence stocks in the limelight is the Atma Nirbhar plan of the Indian government. The government is looking to increasingly farm out defence orders to domestic manufacturers rather than importing. This will reduce the balance of payment pressure, but also encourage Indian defence companies to grow and reduce stress in times of political strife and conflicts.

•    Trade is one of the big drivers of defence in India. Consider these numbers. India’s defence capital outlay has grown at 9% CAGR in the last 6 years. Indigenous purchase of defence equipment in India has gone up at a CAGR of 18% over last 5 years while the defence exports have grown 8-fold in 8 years, albeit on a small base. 

•    Indigenous defence purchases have increased from 54% in 2019 to an estimated 75% in FY24. That is a lot of business for Indian defence companies. However, while army has achieved 83% indigenization, the Air Force is just 56% and even the Navy is just 62%. Therein lies the big opportunity. In FY23 alone, India ordered ₹2.70 trillion of defence equipment with 99% sourced domestically. 

•    Several regulatory changes are likely to help defence companies. For instance, there is already 74% FDI under automatic route, 100% private participation, 411 imports banned and focus on R&D driven business. Government orders have been fair to the public sector and to the private sector in India.

In addition, there is the big prospect of defence exports, but that is just about starting off. The big story now is indigenization and that is what Indian companies are tapping and that would be the focus of the HDFC Defence Fund.
What should investors do? There are varying arguments about NFOs, but we can leave that aside for now. The bottom line is that this is a great opportunity to be part of a long term India centric story. However, defence is not for the short term and it is a long haul game. Things can change rapidly, so this is ideal for investors with slightly higher risk appetite.