Do it yourself: DII

Tuesday, December 24, 2024

Greed consistently dominated fear in 2024, or did it?

The sentiments of greed (risk-taking) and fear (risk-aversion) are two key factors that determine the breadth and depth of the stock market performance over a short term.

In the risk-averse phase usually themes like large cap, defensive, value, dividend yield, etc. lead the market performance. In this scenario, the market breadth is usually narrow; fewer companies raise fresh capital; volatility is low; and market breadth is consistently poor.

On the other hand, in the risk-taking phase, themes like small and midcap, growth, cyclicals, etc. lead the market performance. In an environment supporting risk-taking, usually the market breadth is strong, volumes are above average, and volatility is higher. The primary market is very active in this phase, as a larger number of entrepreneurs look to raise fresh capital for growth and deleveraging.

The year 2024, however, has seen some divergent trends. Several contradictions prevailed, which not only raise doubts about the validity of the current risk-taking phase in the conventional sense, but also present a higher probability of emergence of a severe risk-aversion phase in the near term. For example, consider the following:

· Small and midcap stocks consistently outperformed the benchmark Nifty throughout the year, despite several risk affecting events like BJP not securing majority in the general elections in India; serious escalation in the Middle East Asia geopolitics; outcome of presidential elections in the US threatening a full-scale tariff war; growth slowing materially in Europe, China and India; sticky inflation restricting global easing cycle; corporate earnings failing to meet expectations etc.

· The promoters raised over Rs three trillion through initial public offerings (IPO), qualified institutional placements (QIP), and rights issues. However, most of the QIP and rights issue money was used to deleverage the balance sheets rather than expanding capacities – usually a sign of risk-aversion. Even many of the IPOs were 'offer for sale', where the promoters diluted their stakes.

· Foreign portfolio investors have been net sellers in Indian equities in the year 2024. In the secondary market, FPIs sold over INR 1.1 trillion worth of equities in 2024. However, they bought almost a similar amount in the primary market. The share of the Indian listed market capitalization owned by FPIs fell to ~16%, the lowest level in a decade. The domestic institutional investors however purchased over INR 5.1 trillion worth of equities in the secondary market. The share of the market capitalization owned by the household investors increased to the highest level in the past 15 years.

Historically, the correlation of FPIs’ net flows and Nifty returns in a given year has been poor; but the rise of household share in stock ownership has mostly led to a risk-aversion phase in the markets.

· Despite significant outperformance of the small and midcap stocks, the market breadth and overall traded quantity has not been supportive of a risk-taking trend. In the 6 out of first 11 months of 2024, market breadth has been negative. Overall, the market breadth is neutral. The traded quantity has been mostly below average in the last six months.

· The implied volatility has been mostly moderate to low, except for a brief spike in May 2024 (election month), usually not a sign of a risk-taking phase.

Saturday, December 4, 2021

Are Foreign Portfolio Investors (FPIs) dumping Indian securities?

The media headlines are implying that the foreign investors have been incessantly dumping Indian equities; and this could be one of the primary reasons for currently ongoing correction in the equity prices.

Though there is no evidence of any strong correlation between Nifty and foreign flows over medium to long term (3 months and beyond); these flows have been seen increasing the volatility in near term.

In particular, if the correction in prices is sharper, the selling by foreign investors is highlighted prominently, adding to the nervousness of the non-institutional investors. It is therefore important to know the actual trend of foreign flows; and analyze whether the selling is part of any structural change in their view or just a trading tactics to enhance their return.

The market participants, who track the daily foreign flows closely and get influenced by the provisional net flow data released by SEBI every evening, must note that—

· “Foreign portfolio investors” (FPIs or FIIs) is not a uniform class of investors. This includes a variety of overseas investing entities with divergent investment objective, horizon, and strategies. These include, pension funds having a very long term horizon; hedge funds and alternative investment funds with short term investment horizon; dedicated India funds which raise money from individual investors for investing in India only; emerging market funds which invest in all emerging markets including India; ETFs which track benchmarks like MSCI Emerging Market Index; MSCI India Index; iShare Asia ETF; iShare EM Dividend ETF etc.

All these overseas investing entities usually do not act in unison and mostly have different approaches to investment. Their universe of stocks to invest could also be different.

· The provisional data of FPI net flows, released everyday evening by SEBI does not represent the actual net FPI flows into India. This is just provisional data of net flows into secondary markets as reported by the custodians to SEBI. The real net flows include investment in primary market and debt securities also.

· Many FPIs just run an arbitrage or long short book. They take self-cancelling positions in equities of various regions (e.g., Europe vs Asia), categories (e.g., emerging vs developed), countries (e.g., ndia vs Indonesia) or segments (e.g., cash vs derivative) to take advantage of short term trading opportunities. Their positioning usually does not reflect their fundamental view on a country, region, or category.

· Forex rates could be an important consideration in many FPIs’ investing strategy. Thus, many a times net foreign flows could be influenced by FPIs view on INR exchange rate rather than the equity valuations.

· Selling by FPIs does not necessarily mean outflow from the country. Many times, it is just an asset allocation call between equity and debt; a short term tactical trade; or sale in secondary market to buy in primary market.

An analysis of the trend in FPIs flows for past 10years, and in particular, since the first lockdown (March 2020) due to Covid-19 pandemic, highlights that FPIs have remained consistently positive on India. Despite multiple downgrades of Indian equities by global brokerages like Morgan Stanley, CLSA, Credit Suisse, Goldman Sachs etc., no significant selling has been seen so far. Though, on relative basis the flows to India as compared to other emerging markets might have slowed in past few months.

It is pertinent to note that the sovereign rating upgrade by the global rating agency Moody’s a few months earlier also did not have any noticeable impact on the foreign flows into Indian securities – equity or debt.

In fact, the domestic institutions have invested significantly lower amount in Indian equities in past 10yrs as well as during the period since March 2020, as compared to the net flows of foreign investors.

The following are the key data relating to the foreign and domestic flows:

FPIs’ risk reward is different from Indian investors

In past one decade, Nifty 50 has yielded a return of 215% in INR terms. However, USD denominated Nifty 50 has returned less than half (~106%). The USDINR exchange rate has deteriorated from Rs53/USD in December 2011 to Rs75/USD presently. The yearly average exchange rate of USDINR in past 10years has been Rs66.7/USD. The risk reward of overseas (USD) investors there is very different from Indian (INR) investors. They have to manage the currency risk, in addition to the market and business risks of Indian equities.

FPIs investment in Indian equities consistently more than DIIs

In past 10years, the net investment of overseas investing entities has been mostly higher than the investment made by domestic institutions. Even during the Covid period (since March 2020) FPIs have invested more than the domestic institutions.

In past 10yrs, FPIs have invested a net amount of Rs7.15trn in Indian equities, as compared to Rs2.07trn investment made by domestic institutions. Since March 2020, FPIs have invested a net amount of Rs2.08trn in Indian equities, as compared to Rs26.6bn net investment by domestic institutions.

40% of FPI equity investments are in primary market

Over past 10years, FPIs have net invested Rs7.15trn in Indian equities. Out of this, Rs2.92trn has been invested in primary market and the balance Rs4.23trn in secondary market. On net basis, FPIs’ flow have been negative only once in 2018. However, if we consider secondary market alone, FPIs have been net sellers in 3 out of past 10 years, i.e. 2015, 2018 and 2021.

FPIs sold Indian debt in 2021 despite rating upgrade

FPIs have invested Rs1.69trn in Indian debt securities in past 10years. Since March 2020, they have net sold Rs921bn worth of Indian debt.

The lower FPI investment in debt, despite high yield differential with developed markets, could be a matter of concern. Lower rating and lower FPIs quota in government securities could have been couple of many reasons for the low interest in Indian debt. However, even a rating upgrade few months ago and materially increase in quota during past few years has not resulted in flows into Indian debt securities.

Interestingly, FPIs have been net sellers of Indian debt in 5 out past 10 years.

FPI flows and Nifty poorly correlated

As mentioned above, FPI net investment is significantly larger than the domestic institutions’ net investment in Indian equities. However, there is little evidence to indicate that FPI flows materially influence the market direction over a longer period. Even on monthly basis the correlation between FPI flows and volatility is poor.

Conclusion

FPIs are not a uniform class of investors. However, collectively they have been positive on Indian equities for long. There is no evidence to indicate that they are dumping Indian equities or causing unusual volatility in Indian markets. The headlines like “Foreign Investors dumping Indian Equities” therefore are best ignored. As per Prime Database, FPIs are presently invested in 1370 listed companies in India, an all-time high number. It would therefore not correct to say that FPIs invest in only a specific set of stocks; or only large cap stocks etc. Also, presently FPIs hold ~21% of all NSE market cap as compared to ~7.3% for all mutual funds in India. Thus after promoters (~51%), FPIs collectively own the largest share in listed Indian companies.