The clout of domestic investors on Indian stock markets has augmented more than ever before, with the benchmark indices recurrently scaling new highs. The upsurge in mutual fund equity flows has given a new connotation to Indian equity markets. The mutual fund equity inflows and stock market performance are developing a positive correlation, which was not the case till a couple of years ago, because hitherto the quantum of foreign fund flows used to determine the equity market performance. Hence, one can rightfully claim that Indian equity market valuations are increasingly getting Made-in-India, given that household savings are incrementally being channelized towards financial products.
John Maynard Keynes, British economist and champion of free markets, said, “The importance of money flows is a link between the present and the future." Keynes believed that the unique function of money is to carry us from where we are currently to where we are destined to go. The increased participation from domestic investors in Indian equity markets submits that they are scripting a promising future for themselves.
A study reveals that between 2004 and April 2014 (pre-general elections), monthly equity flows and MSCI India Index performance had a strong correlation. MSCI India (US$ Index) performance declined 7% (median) over the same period in concurrence with foreign fund selling. However, the trend has altered since May 2014—MSCI India Index has declined less than 1% (median) during periods of foreign institutional investors (FII) selling, and this illustrates the increasing might of domestic flows.
Of these, Indian household savings have become a dominant driver of local institutional flows. Mutual funds had pumped in Rs48,005 crore, as against Rs18,783 crore by FIIs in 2016, shows investment data. This reflects the appetite of domestic investors for equity markets (Source: NSE, BSE, Sebi and Amfi).
Peter Lynch, legendary value investor, mutual fund manager, and philanthropist, said “There are substantial rewards for adopting a regular routine of investing, and following it no matter what, and additional rewards for buying more shares when most investors are scared into selling." Hence, investors planning to participate for long term in Indian equity markets should follow Lynch’s counsel for rich dividends.
Mutual funds have unfailingly received significant inflows through systematic investment plans (SIPs), which were deployed in equity markets. Incidentally, demonetization has been a game changer for the mutual fund industry, as equity inflows have touched new highs after the November move. This was also at a time when large section of investors had turned cautious about investing in other asset classes like gold and real estate. This has been reflective in the subscriptions into SIPs, which has been rising consistently. Data from the Association of Mutual Funds in India (Amfi) shows monthly inflow of Rs4,269 crore through SIPs in April 2017, as compared to just Rs980 crore per month in 2012, aptly reflecting the increased interest in recurring savings allocations.
Hearteningly, it is the balanced fund category that has witnessed strong momentum as Indian savers are gradually gravitating from physical to financial savings with first billion dollar-plus monthly inflows into balanced funds (aggregate net subscription for April 2017 stood at a historic high of $1.1 billion). Mutual funds’ equity and equity-linked savings schemes (ELSS) witnessed an aggregate net inflow of Rs94 billion ($1.5 billion) in April 2017, which is more than twice the April 2016 inflows, and 61% higher than the past 12-month average.
However, Indian stock market valuations currently appear somewhat expensive, against historical averages. The trailing price-to-earnings (P-E) multiple for S&P BSE 500 Index is currently trading at 26 times or close to 2 standard deviations above the long-term average. In addition, more than a quarter of stocks are trading at over 40 times trailing 12-months earnings, the highest ever. To provide a perspective, in December 2007, the median P-E for the market was 21 times, and 24% of the stocks were trading over 40 times trailing P-E. However, historical market patterns point that sooner than later, markets tend to realign to historical valuations, typically as and when earnings growth materializes.
Nevertheless, one should always remember that no one asset class has ever moved in a straight ascending line, and, when it comes to financial assets in particular, the exhibition of volatility is even more prominent. Indian equity markets are trading around all-time high, and given the interesting and dynamic market environment, it calls for a rebalancing of portfolio, Hence, a suite of products such as dynamic asset allocation or balanced advantage category of funds are recommended for investors as they prepare to navigate the probable volatile times in the days ahead.
We anticipate the Indian market performance to be determined by the earnings growth trajectory and GST implementation. Surging domestic liquidity and high secondary market valuations also bode well for corporate deleveraging or reduction in cost of capital, which may further bolster equity market sentiments. Also, the recent domestic and international political developments have been favourable for investor risk appetite. Interestingly, these are good times to remain invested in stock markets, as Indian economic growth soars to a robust 7%-plus, making it the fastest growing emerging market globally.
Nimesh Shah is managing director and chief executive officer, ICICI Prudential Asset Management Co. Ltd