Your Questions Answered: I want to invest in the defence sector. Please elaborate on the Nifty Defence Index

Nifty Defence Index mirrors Indian Defence sector growth, attracting investors seeking diversification. Mutual funds tracking this index offer exposure to stable sector with growth potential, but investors must consider risks and ethical implications.

Kuvera
First Published14 Jun 2024, 09:06 AM IST
Exploring the Nifty Defence Index: A Strategic Investment Avenue in India's Defence Sector
Exploring the Nifty Defence Index: A Strategic Investment Avenue in India’s Defence Sector(iStock)

I am an office admin head working with a mid tier law firm in Mumbai. My husband is an accountant working with the same firm. We have been investing in debt mutual funds and Nifty Index Funds for the past 5 years. We now intend to diversify our portfolio and invest in index funds tracking the defence sector. Can you please elaborate on the Nifty Defence Index and the pros and cons of investing in a mutual fund tracking the Nifty Defence Index?

Shreya Mirchandani, Mumbai, Maharashtra

The Nifty Defence Index is a pivotal financial instrument that encapsulates the performance of the Indian defence sector. It is a thematic index that tracks the performance of a portfolio of stocks representing companies significantly involved in the defence industry. This index is particularly relevant for investors looking to capitalise on the growth potential of India's defence sector, which is rapidly expanding due to increased government spending and initiatives to promote self-reliance in defence production.

Also Read: What are the pros and cons of investing in index funds tracking the Nifty Consumption Index?

Understanding the Nifty Defence Index

The Nifty Defence Index is a specialised equity index that aims to track the performance of stocks representing the defence sector within the Indian market. For investors and companies alike, understanding the eligibility criteria for inclusion in this index is crucial, as it not only reflects a company's standing within the defence sector but also offers visibility and potential investment opportunities.

Association with the Defence sector: To be considered for the Nifty Defence Index, a company must be significantly involved in the defence sector. This involvement can be demonstrated in two ways: 

(a) The company is part of the eligible 'basic industries' as per the Association of Mutual Fund Industry classification.

(b) The company is listed in the Society of Indian Defence Manufacturers (SIDM) member list and derives at least 10% of its revenues from the defence segment.

Part of the Nifty Total Market Index: A prerequisite for a stock to be eligible for the Nifty Defence Index is that it must already be part of, or going to form part of, the Nifty Total Market index at the time of review.

Market capitalization: The selection of stocks for the index is based on a six-month average free-float market capitalization. This ensures that the stocks included are reflective of the market's valuation of the company's equity that is readily available for trading.

Weightage caps: To maintain diversification and avoid over-concentration, the weight of any single stock in the index is capped at 20%. This cap ensures that the index is not overly influenced by the performance of just one or a few stocks.

Minimum number of stocks: The index maintains a minimum number of stocks, which is set at 10. This criterion ensures that the index represents a broad spectrum of companies within the defence sector.

Semi-annual reconstitution: The Nifty Defence Index undergoes a reconstitution semi-annually. This process allows for the inclusion of new eligible stocks and the exclusion of those that no longer meet the criteria, ensuring the index remains up-to-date with the current market scenario.

Corporate events: A company that has undergone corporate events such as spin-offs or capital restructuring may be considered for inclusion if it has completed three calendar months of trading post-event, provided it meets all other eligibility criteria.

Also Read: What is the Nifty 100 Low Volatility 30 Index and its pros and cons?

Composition and Characteristics

Base date and value: The index has a base date of April 02, 2018, with a base value of 1000, providing a benchmark to measure growth.

Minimum constituents: The index maintains a minimum of 10 stocks to ensure diversification.

Capping of stock weights: Individual stock weights are capped at 20% to prevent over-concentration.

Reconstitution: The index undergoes semi-annual reconstitution alongside Nifty Broad-based indices to stay current with market changes.

Top constituents

The Nifty Defence Index comprises leading companies in the defence industry, such as Bharat Electronics, Hindustan Aeronautics, and Solar Industries, among others. These companies are involved in a range of activities from defence production to research and development of advanced technologies. The index's constituents are periodically reviewed to ensure they meet the eligibility criteria and accurately represent the sector's performance.

Investing in mutual funds that track specific indices can be a strategic move for many investors, offering a blend of stability and sector-specific focus. One such niche area is the defence sector, tracked by the Nifty Defence Index. Here's a detailed exploration of the advantages and disadvantages of investing in mutual funds that follow this index.

Also Read: What are pros and cons of investing in Nifty MidSmallcap400 Momentum Quality 100 Index?

Pros 

Diversification within a sector: Investing in a mutual fund tracking the Nifty defence Index allows investors to gain exposure to a variety of companies within the defence sector. This can help spread out risk while still focusing on a specific industry.

Stable investment in a niche market: The defence sector is often considered stable due to consistent government spending and long-term contracts. This can make mutual funds tracking the defence index a less volatile investment compared to other sectors.

Potential for growth: With increasing global tensions and a focus on national security, the defence sector may see growth. Investing in a mutual fund tracking the Nifty defence Index could capitalise on this potential.

Passive management: Index funds are typically passively managed, which means lower management fees for investors. This cost-saving can be particularly beneficial over the long term.

Cons 

Sector-specific risks: While diversification within the defence sector is possible, investors are still exposed to risks specific to this industry, such as changes in government policy or defence spending.

Investment implications

The Nifty Defence Index offers investors a strategic approach to investing in India's defence sector. By tracking a curated portfolio of companies, the index provides exposure to a critical industry that is poised for growth due to the country's strategic initiatives and geopolitical context. It serves as a useful tool for investors seeking to diversify their portfolios with defence stocks, which can offer the potential for long-term capital appreciation.

Taxation 

Investing in mutual funds that track specific indices, such as the Nifty defence Index, has become a popular choice for individuals looking to diversify their portfolios and align their investments with particular sectors of the economy. Understanding the tax implications of these investments is crucial for making informed decisions and optimising returns.

Also Read: What is the difference between mutual funds tracking Nifty Bank Index and Nifty PSU Bank Index?

Equity index funds and taxation

Mutual funds that track an equity index, like the Nifty defence Index, are classified as equity mutual funds for tax purposes in India. The taxation of equity index funds is contingent on the duration for which the investment is held, distinguishing between short-term and long-term capital gains.

Short-Term Capital Gains (STCG): For holdings less than a year, short-term capital gains tax is levied at a rate of 15%. This means that if an individual sells their mutual fund units within a year of purchase, any profit made will be taxed at this rate.

Long-Term Capital Gains (LTCG): For investments held for more than a year, long-term capital gains tax applies. The rate is set at 10% for gains exceeding 1 lakh. It's important to note that there is no indexation benefit available for equity mutual funds, which means the purchase price is not adjusted for inflation for the purpose of calculating taxable gains.

Dividend taxation

Dividends received from mutual funds were previously tax-free in the hands of investors. However, as per the Finance Act 2020, dividends are now taxable at the applicable slab rates of the individual investor. Additionally, the mutual fund house is required to deduct TDS at 10% if the dividend amount exceeds 5,000 in a financial year.

In conclusion, the Nifty Defence Index is more than just a financial metric; it is a testament to India's growing capabilities and commitment to bolstering its defence sector. For investors, it represents an opportunity to participate in a sector that is not only vital for national security but also offers significant economic potential. As India continues to make strides in self-reliance and innovation in defence, the Nifty Defence Index will remain a key barometer of the industry's progress and investment attractiveness. 

Mutual funds that track the Nifty defence Index offer a focused investment in a stable sector with potential for growth. However, investors must consider the sector-specific risks, limited diversification, and ethical implications before investing. As with any investment, it's crucial to align it with your financial goals, risk tolerance, and investment horizon. For more detailed information on the Nifty defence Index and related mutual funds, financial advisors and market analyses can provide valuable insights. 

Disclaimer: Investing in mutual funds involves risks, including potential loss of principal. Please consult with a financial advisor before making any investment decisions.

Kuvera is a free direct mutual fund investing platform.

 

 

 

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First Published:14 Jun 2024, 09:06 AM IST
HomeMutual FundsYour Questions Answered: I want to invest in the defence sector. Please elaborate on the Nifty Defence Index

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