Defence stocks offer best defence

As the Iran war drags on, focus has shifted again on this sector

Over the past 12 months, India’s defence stocks witnessed a boom, especially after last year’s India-Pakistan tech-drone-missile war. While their prices are up by 18 per cent, the financials are likely to grow by a similar percentage in the future. Several analysts contend that these may be the best defensive stocks to buy in the current war scenario. Apart from the geopolitical situation, India’s rising defence budget, focus on local production and exports, and ongoing tensions on the borders may augur well for these shares.

Defence spending is in focus globally. Recently, Donald Trump’s budget proposed an annual expenditure of $1.5 trillion, or more than 40 per cent increase over the previous year, and the “largest expansion in (America’s) military spending since World War II.” Indeed, the planned rise is at the expense of several development and welfare areas such as climate, housing, and education. Total global defence expenditure crossed $2.7 trillion in 2024, thanks to the geopolitical tensions, regional conflicts (Russia-Ukraine war), and a shift towards a multipolar world order (the US vs China, Russia).

India has emerged as a key participant in this structural trend. The country’s defence budget grew by nearly 2.7 times since FY-14, and reached Rs 6,80,000 crore in FY-26. This reflects a long-term commitment by the government to modernise the infrastructure, existing strategic capabilities, and equipment. Domestic production has nearly doubled over the past five years, with ambitious targets set to double output again by 2029. The use of indigenous equipment was visible in the India-Pakistan drone war last year. Exports surged, and rose from less than Rs 2,000 crore in FY-17 to over Rs 23,000 crore in FY-25, or a jump of more than 11 times in eight years.

Mutual funds or exchange-traded funds (ETFs) that replicate a carefully curated basket of firms that derive a significant portion of revenues from defence-related activities are, therefore, in vogue. They mirror the Nifty Defence Index, which includes firms engaged in aerospace, equipment manufacturing, shipbuilding, explosives, and allied services. The selection is based on defined eligibility criteria, which are weighted as per the free-float market cap, with limits to ensure diversification. The index is rebalanced twice in a year, which aims to provide a disciplined and transparent investment framework.

Along with a fund launched by Axis Mutual Fund, the index-based sector-specific is still nascent, and growing. Among the key offerings are the Motilal Oswal Nifty India Defence Index Fund, which was among the first to track this theme. Over the past 12 months, its returns were nearly 30 per cent, as was the case with two other funds and ETFs. Over a three month-period, the last three, the three funds offered returns of just over nine per cent each. During the same period, the Sensex, the Bombay Stock Exchange Index, lost more than 5,000 points. Since January 1, 2026, the overall index shed a massive 6,500 points.

One of the advantages of defence index funds is the simplicity. Investors get exposure to a curated basket of sector-related firms without a need to research on the individual stocks. They are cost-efficient, as passive funds typically have lower expense ratios compared to the actively-managed funds. The rules-based approach ensures transparency and discipline, with periodic rebalancing that is aligned with the Nifty Defence index. Defence funds offer thematic diversification. Since these stocks may not be heavily represented in broader indices, the funds allow investors to tap into a specific growth segment.

Despite the strong narrative, these funds come with notable risks. The main one is the obvious concentration risk. The index that they mirror, and replicate, includes a limited number of stocks. As one knows, defence is highly prone to policies and regulations, which include changes in official spending, or geopolitical dynamics. Valuations offer another area of concern. In the recent past, the stocks witnessed sharp rallies, as well as strenuous periods of corrections. The reason is that they are synced with specific events related to wars and conflicts. Thus, the sector per say behaves in a volatile manner.

Being passive in nature, and as per their strategy, these defence funds cannot actively avoid overvalued stocks, or adjust allocations based on the market conditions. Yet, experts believe in long-term structural play, supported by multiple tailwinds. B Gopkumar, MD & CEO, Axis AMC, explains, “India’s defence sector is undergoing a multi-year transformation, supported by rising budgets, strong policy intent, and expanding export opportunities. We (through our fund) offer investors a low-cost, rules-based way to participate in this structural growth theme. This (Axis’) fund is well-suited for investors with a long-term perspective who are looking to align their portfolios with India’s strategic and manufacturing priorities.”

Hence, one can look at the defence funds in two ways, which are essentially the two sides of a coin. When one looks at the heads, one sees a compelling growth story, which is driven by global factors (multi-polar world), and domestic situations (tense borders). There is transparency, and lack of gimmicks, as the sector is simple and straightforward. Defence will invariably remain on the top of any regime’s agenda. Yet, if one looks at the tails side, the investors need to be willing to remain invested in the funds, or have confidence in the sector through ups and downs, and volatile cycles.

As of now, the defence-themed index fund space remains small and niche. As mentioned earlier, there are only a handful of funds that track the sector-specific Nifty index. Hence, investors with less risk appetite, or safety issues, may wait for a while to understand how these funds perform, and what are the benefits and pitfalls. For those with a little bit of courage, and confidence in India’s security strategy, the defence funds may offer an early, lucrative entry into a new area. Policy support, growing global relevance, and focus on local production may help the sector to emerge as a significant investment theme.

Globally, there is a buzz around the defence stocks. In the US, for example, the Iran war has “depleted certain munitions, and increased demand for replenishment.” Experts reckon that bases store 50 million gallons of jet fuel each month, and tanks in drills consume 1,000 gallons of fuel per mile. “Defence contracts regularly invest $3 billion in armoured carriers that feed off the diesel round the clock,” states a media report. This is why the shares of Lockheed Martin, which won a $5-billion defence contract, are up nearly 29 per cent this year.