Mumbai: There is a serious disconnect between the view of foreign institutions on Indian equities and the flow of money, purportedly from the very same people.
Foreign institutional investors (FIIs) have brought in funds worth $2.6 billion in just the past seven trading sessions at a time when most emerging market strategists and fund managers are underweight on India.
India seems to have got more than its fair share of FII allocations. This is because the Indian markets have been among the best performing markets in the world since the US Federal Reserve (Fed) interest rate cut, thanks only to FII inflows.
Domestic institutions have been busy booking profits on each of the past seven trading sessions—cumulatively, they have sold equities worth $850 million. While most analysts had predicted that the cut in the Fed rate would lead to inflows into emerging markets, the surge of funds into India is surprising, given the underweight stance of most FII brokers and strategists.
UBS Investment Research’s equity strategy report of 26 September is a case in point. Not only does it affirm its underweight stance on India, but UBS global equity strategists Jeffrey Palma and colleagues wrote that investors should demand a higher risk premium for the Indian markets, which ranks the second lowest (above Argentina) among 16 global emerging markets in terms of economic and political risk profile.
What makes things worse, as the UBS report pointed out, is that there is a disconnect with the valuations of the Indian markets vis-à-vis the risks involved.
A September Merrill Lynch survey of emerging market fund managers also pointed out that India, Malaysia, Poland and Chile were the top four markets on which fund managers were underweight or short. While Asia was the preferred region, 50% of the managers surveyed were underweight on India, while only 21% were overweight. Among the so-called Bric (Brazil, Russia, India, China) countries, India was the least preferred, with a net 42% being underweight.
Andrew Holland, strategic investment managing director at DSP Merrill Lynch in India, pointed out that although the majority continue to be underweight, the position has improved in the past month. In August, 68% were underweight and just 9% were neutral on the Indian markets. In September, this improved to 50% underweight and 29% neutral. Even this shift in stance would lead to inflows into the market, Holland said.
But that alone wouldn’t account for the huge inflows in the past eight trading sessions. Citigroup’s chief Asia strategist Markus Rosgen said: “Our survey data suggests that the resounding majority of institutions are underweight on India.” It could be retail money from Japan or West Asia investors, he speculated.
Rosgen’s team is underweight on the Indian market by about 200 basis points relative to the benchmark MSCI index. Krishna Kumar Karwa, managing director of Emkay Stock Brokers, said that while it is difficult to ascertain where the ultimate source of FII flows lies, he has been hearing that Japanese money is entering the markets currently.
It may seem ironic to term institutional flows as non-institutional, but about half of FII inflows are through the issuance of participatory notes (P-notes). These notes could be issued by FII brokers to retail clients overseas, so it is not right to label all FII inflows as institutional. Around 40% of FII flows are said to be through the issue of P-notes.
The reason a majority of global fund managers are underweight on India is that valuations are relatively high compared with other regions. Another concern is that earnings growth is slowing, Rosgen added. But that’s not to say there aren’t any buying opportunities in India.
According to Rosgen, capital goods, banking and telecom companies in India are strong growth sectors. The Indian market is expensive at current valuations compared with many other emerging markets, agreed Hasan Askari, chief executive of Old Mutual Plc. for the Asia-Pacific region. “However, institutional investors will continue to buy Indian equity assets with a mid- to long-term view,” said Askari. Old Mutual has large investments in Indian equities as a foreign institutional investor.
Mukarram Bhagat of ASK Securities said: “Some part of the foreign investments may be because of the currency appreciation. With the rupee expected to continue appreciating, foreign investors get a decent return on their equity investments even if stocks were to remain flat.” But this reason alone is unlikely to attract large inflows, as it is fraught with the risk that markets may fall.
However, global fund managers are still very confident on Indian equities, says Jyoti Jaipuria, head of research at Merrill Lynch in India. “Foreign investment in Indian equities is bound to rise. Most of the global fund managers are taking a longer-term shot on India.”