Are Mutual Funds Betting on Capital Goods ?

Capital goods made up 7.8% of mutual fund equity portfolios in April 2026, the third-largest sector exposure after private banks and automobiles. Fund managers added to it over the year (+90 basis points YoY, +60 bps month-on-month). But the sector now trades at around 41x one-year forward earnings, against a 10-year average of 27.5x.

This blog explains why mutual funds are increasing capital goods exposure, which schemes hold the most, and the valuation risk that comes with the trade.

Why Mutual Funds Are Increasing Capital Goods Exposure

The buying is supported by real-economy demand, not just market sentiment. Four drivers stand out.

1. Government capex remains high. The Union Budget proposes public capital expenditure of ₹12.2 lakh crore for FY2026-27. Capital goods companies benefit directly through infrastructure, power, railways, defence, roads and logistics projects.

2. Industrial production is growing. India's capital goods output grew 14.6% YoY in March 2026, and infrastructure/construction goods grew 6.7% YoY. This shows output is rising in the real economy, not only in stock prices.

3. Power transmission is a multi-year opportunity. India's National Electricity Plan points to a transmission investment opportunity of around ₹9.15 lakh crore until 2032. This supports companies making transformers, cables, switchgear and grid equipment.

4. Defence manufacturing is being localised. For FY2026-27, the government allocated ₹1.39 lakh crore for procurement from domestic defence companies, with around 75% of the capital acquisition budget reserved for domestic sourcing. This benefits defence electronics, aerospace, shipbuilding and public-sector manufacturers.

Continued policy support for domestic manufacturing and MSMEs adds to these tailwinds, which is why allocations have risen across fund houses.

How much each Fund House Holds

At 7.8%, mutual funds are marginally overweight versus the BSE-200 benchmark weight of 7.7%, but the average hides a wide split between fund houses.

Which Schemes hold the most?

Capital goods exposure is no longer limited to thematic funds. Several large diversified small-cap, mid-cap and multi-cap funds hold the biggest rupee amounts.

The Key Insight: Conviction is not the same as Market Impact

A fund's percentage allocation shows conviction. Its rupee exposure shows actual market impact, and the two can point to different funds.

HDFC Defence Fund has the highest concentration at 56.67% of its portfolio in capital goods, followed by HSBC Infrastructure Fund at 41.78%. But Nippon India Small Cap Fund holds far more in absolute terms, around ₹13,746 crore, because its overall AUM is much larger, even though its allocation is "only" 18.93%. For an investor, a high-percentage thematic fund signals conviction; a large diversified fund with big rupee exposure is what actually moves sector flows.

The Main Risk: Valuations

The sector has already delivered strong returns, which is now reflected in the price.

On a forward basis, the sector trades at around 41x earnings versus a 10-year average of 27.5x, roughly 1.5 times its own history. In simple terms, capital goods is no longer a cheap recovery trade; it is priced for companies to keep delivering. From here, returns depend on earnings growth, not further rerating.

Things to keep in mind

• The valuation premium is large. At 41x forward earnings versus a 27.5x average, much of the optimism is already in the price.
• High exposure is concentrated in small- and mid-cap funds, which carry more volatility than large-cap or diversified funds.
• The theme depends on execution. The macro drivers (capex, defence, power) are real, but companies must convert order books into actual earnings.
• Thematic funds (defence, infrastructure) are the most concentrated and therefore the most exposed to a single-sector correction.
• Sector flows can reverse quickly. A 60 bps monthly rise shows momentum, but momentum fades fast if earnings disappoint.

The Bottom line

Mutual funds are backing capital goods because the manufacturing, defence, power and infrastructure cycle is genuinely strong, and the buying spans diversified funds, not only thematic ones. But at nearly 1.5 times its historical valuation, the sector has shifted from a cheap cyclical bet to a priced-for-execution trade. For investors, the macro story is intact; the open question is whether earnings can justify the price.