In recent years, India’s defence sector has undergone notable structural changes. The government has focused on strengthening domestic manufacturing capabilities, reducing import dependence, and encouraging participation from private companies alongside public sector enterprises.
With increasing attention on defence manufacturing and related industries, some investors have begun exploring investment avenues linked to this sector. Some defence-focused mutual funds and exchange-traded funds (ETFs) have emerged to provide exposure to companies operating in defence manufacturing, aerospace, shipbuilding, electronics, and allied segments.
This article explains what defence-focused mutual funds and ETFs are, how they function, why the theme is being discussed more frequently, and what investors may consider before investing.
Table of Contents
What is a defence ETF or mutual fund?
A defence mutual fund is generally thematic equity mutual fund, index fund or ETF that invests predominantly in companies associated with the defence and aerospace ecosystem. These may include businesses involved in military equipment manufacturing, electronics systems, engineering services, shipbuilding, aerospace components, and related technologies.
Defence ETFs and defence mutual funds provide sector-specific exposure through a pooled investment structure. Since these schemes typically invest primarily portfolio in equities, they are generally classified as very high risk investment products. Moreover, they may be more concentrated than funds tracking the broader market.
Such funds aim to capture potential opportunities arising from developments within the defence sector. However, returns remain market-linked and depend on company performance, sector conditions, and broader equity market movements.
Also Read: Thematic vs. Sector Funds: Key Differences
Defence mutual fund vs Defence ETF
Defence mutual funds and Defence ETFs both provide exposure to the defence theme, but they differ in structure and mode of investing.
Defence Mutual Fund (Active or Passive)
Defence mutual funds are offered by asset management companies and may follow either an active or passive strategy. An actively managed defence fund relies on fund manager research and portfolio decisions within the thematic universe. A passive defence fund seeks to replicate the performance of a defence-related benchmark index, subject to tracking error.
Defence ETF
A defence ETF generally tracks a defence-related index, such as the Nifty India Defence Index. ETF units are listed on stock exchanges and can be bought or sold during market hours through a demat and trading account.
Both structures remain subject to market risk, and neither provides any assurance of returns.
Why Defence Funds are gaining popularity
Interest in defence funds has grown alongside changes in government policy, domestic manufacturing and private-sector participation. The main reasons include:
Policy focus on domestic manufacturing
India’s defence policy has increasingly emphasised domestic production through initiatives such as Make in India and indigenisation programmes. These initiatives aim to strengthen local manufacturing capabilities over time. Policy direction may create potential opportunities for listed companies engaged in defence manufacturing and services.
Increasing role of private companies
Historically, defence production in India was dominated by public sector undertakings. Over time, private companies have entered segments such as electronics, components, subsystems, and design services. This is validated by the Make in India Defence initiative, of which the second phase – Make II – was industry funded with a goal of import substitution.
Long-term strategic nature of defence spending
Defence expenditure is typically planned over multi-year horizons. While this may provide some visibility into sector demand, company revenues may remain uneven due to project timelines, procurement procedures, and policy changes.
Growing awareness of thematic investing
Investors have become more aware of thematic mutual funds as a distinct category within equity investing. Defence-themed products are often discussed alongside other sectoral funds such as infrastructure, manufacturing, or energy funds.
*Sources: Make in India Defence website, “Defence Atmanirbharta: Record Production and Exports”, Press Information Bureau, November 20, 2025.
Defence mutual fund in a portfolio
A defence mutual fund portfolio generally includes companies involved in designing, developing, manufacturing, or supplying defence-related products and services.
These portfolios may contain a mix of public sector enterprises and private sector companies operating across aerospace, naval systems, electronics, engineering, and technology segments. Because thematic funds concentrate investments within a specific sector, diversification remains limited compared with diversified equity mutual funds.
Although defence spending is linked to government budgets, equity investments in this sector remain market-linked and may experience periods of volatility. Defence mutual funds therefore generally carry very high risk due to sector concentration.
Also Read: Opportunity Funds: Meaning, Benefits & How to Invest?
Key benefits of investing in defence mutual funds
Defence mutual funds give investors access to different parts of the defence sector through a single investment. Their key potential benefits include:
Government policy support
Government initiatives promoting domestic defence manufacturing and indigenisation may create potential opportunities for companies operating within the sector over the long term.
Structural industry development
India’s defence production has expanded in recent years alongside policy initiatives encouraging local manufacturing and private participation. Industry development may support business expansion for certain companies, subject to execution and competitive factors.
Sectoral exposure
Defence mutual funds provide exposure across segments such as aerospace, shipbuilding, electronics, engineering, and defence equipment manufacturing.
Technology and innovation exposure
Some defence companies operate in areas such as advanced electronics, cybersecurity, drones, and artificial intelligence applications. These areas may offer long-term growth potential, although technological and execution risks remain.
Export opportunities
India’s defence exports have shown growth over recent years. Expansion into international markets may create additional revenue opportunities, subject to global demand conditions and geopolitical developments.
Order book visibility
Large defence contracts may provide revenue visibility for certain companies. However, earnings may fluctuate due to project execution timelines, contract revisions, or procurement delays.
Risks of investing in defence funds
Defence funds focus on one theme, which can make them more sensitive to developments within that sector. Investors should consider the following risks:
Sector-specific risks
Defence mutual funds are exposed to risks specific to the defence industry. Changes in government policy, defence budgets, procurement decisions or geopolitical developments may influence company performance and fund returns.
Concentration and volatility
Because these schemes invest predominantly in a single sector, their prices may be more volatile than those of diversified equity mutual funds. Defence funds therefore require a very high risk appetite.
Policy and procurement risk
The sector depends significantly on government budgets, policies and procurement decisions. Changes or delays in these areas may affect company revenues and, in turn, fund performance.
Valuation risk
Strong investor interest can push defence-stock valuations higher. If company earnings do not meet market expectations, prices may correct even if the sector’s long-term outlook remains positive.
Project execution risk
Defence orders may take several years to complete. Delays, higher costs or changes in contract terms can affect the earnings of companies held by the fund.
Liquidity risk
Some defence funds may hold small cap or mid cap stocks that are traded less frequently. Depending on the portfolio, this may make the scheme more sensitive to sharp market movements.
Also Read: Business Cycle Mutual Funds: Meaning and Benefits
Things to consider before investing in a defence fund
Since a defence fund is focused on one or a few sectors, investors should consider the following factors before choosing one:
- Your risk appetite: Defence funds invest within a limited theme and may experience sharp changes in value. Check whether you are comfortable with the scheme’s Riskometer level.
- Investment horizon: Sector growth and defence projects may take time to translate into company earnings. The fund should suit the period for which you can remain invested.
- Role in your portfolio: A defence fund may be considered as a limited thematic allocation rather than a replacement for a diversified core portfolio.
- Scheme strategy: Check whether the scheme is actively managed or tracks an index. Also review its investment objective, benchmark and stock-selection approach.
- Portfolio concentration: Look at how much of the portfolio is held in its largest stocks and whether it is spread across different parts of the defence ecosystem.
- Valuations: A promising sector can still be expensive. High stock valuations may limit future return potential or lead to a correction if earnings fall short of expectations.
- Costs and liquidity: Review the expense ratio and exit load. For an ETF, also consider trading volume, bid-ask spread, tracking error and the need for a demat account.
- Recent performance: Strong past returns may attract attention, but they do not show how the fund will perform in the future. Study performance across different market conditions instead of relying on a recent rally.
Past performance may or may not be sustained in future.
Conclusion
Defence-themed mutual funds and ETFs offer focused exposure to a sector linked to India’s strategic and industrial development. These schemes provide thematic participation through equity markets but remain subject to sector concentration risk, policy dependency, and market volatility. Defence mutual funds may be considered as a limited allocation within a diversified portfolio by investors who understand thematic investing and are comfortable with fluctuations. Investment outcomes remain market-linked and are not guaranteed.
FAQs
Is it better to invest in a defence ETF or an active defence mutual fund?
Both structures function differently. A defence ETF passively tracks a benchmark index and generally follows a rule-based approach, while an active defence mutual fund relies on fund manager decisions within the thematic universe. Suitability depends on investment preference, costs, and trading convenience.
What is the outlook for Indian defence exports?
India has introduced policy initiatives to encourage defence exports and international partnerships. While this may create potential opportunities, actual export growth depends on competitiveness, execution capability, geopolitical conditions, and global demand trends.
Are defence mutual funds recession-resistant?
Defence spending may be planned over longer horizons compared with some sectors; however, defence mutual funds remain equity investments. Market cycles, valuation changes, and company-specific developments may still result in volatility.
Why is a defence fund’s performance so volatile?
Performance volatility may arise from sector concentration, contract-related announcements, policy developments, valuation changes, and the presence of mid cap and small cap companies within defence sector portfolios.
How to choose a defence fund before investing?
Compare the scheme’s investment objective, active or passive strategy, benchmark, portfolio concentration, expense ratio and Riskometer level. For an ETF, also check trading volume, bid-ask spread and tracking error. Review performance across different market conditions, but avoid choosing a fund only based on recent returns. Past performance may or may not be sustained in future.
Who may consider investing in a defence fund?
A defence fund may suit investors with a very high risk appetite, a long investment horizon and an diversified portfolio. It may be considered for limited thematic exposure to the defence sector. Such funds may not suit conservative investors, those with short-term goals or anyone uncomfortable with sharp fluctuations in investment value.
