Why markets rose 17% in less than one year

A first in 7 years, the combined institutional investor flow stands at Rs 69,000 crore in 2016-17

It is not often that inflow from foreign and domestic institutional investors trend in the same direction. Typically, when foreigners sell, the domestic guys buy and vice versa.

This financial year, however, both foreign portfolio investors (FPIs) and domestic institutional investors (DIIs) have put money in Indian equities. This is the first time since 2009-10 that net inflow from both these classes of investors has been on the positive side.

Since April 1, 2016, DIIs and FPIs have together put in nearly Rs 69,000 crore, helping the markets climb 17 per cent. In comparison, during 2009-10, they had collectively pumped in about Rs 1.35 lakh crore, helping the markets stage a sharp V-shaped recovery after the 2008 global financial crisis.

Historically, FPIs have been the dominant market price-setters, given their size and trading patterns in India. The past couple of years have indicated a definite change of guard, with DII flows increasingly being the primary driver of market direction and displacing FPI flow as the price-setter.

DIIs have pumped in excess of Rs 1 lakh crore in the past two financial years, mostly led by robust investment from mutual funds (MFs). This compares with inflow of Rs 24,000 crore from FPIs during the period.

The rise in the share of domestic investors reduces dependence on the more volatile foreign inflow, say market experts. Over the past 30 months, the trend of investing through systematic investment plans (SIPs) into MF schemes has increased. There are now a little over 10 million SIP accounts, with an average size of Rs 3,500.

DIIs’ participation in Indian equities has also been boosted by Life Insurance Corporation of India (LIC), the country’s largest insurer, which has raised its equity investment over the past few years.

The total value of LIC holdings has risen by a little more than 50 per cent since December 2012 to Rs 4.7 lakh crore at the end of the December 2016 quarter.

“An equity investment culture is rising and is taking a more formal form. Most new-age investors are professionals earning a livelihood in other industries; stock markets are simply a vehicle for their savings. Given the lack of expertise, resources and time, these investors are investing through insurance schemes and MFs,” goes a recent note by foreign brokerage Jefferies.

FPIs were net sellers in FY16. They sold heavily in the December quarter of FY17, owing to the flight of capital from emerging markets, following the uncertainty surrounding the US election and the possibility of aggressive rate hikes by the US Federal Reserve. The impact of note ban in India had also spooked investors.

This tide has turned in the ongoing March quarter, however, with no negative surprises in Union Budget 2017-18 and the recent win by the ruling Bharatiya Janata Party in the assembly elections of Uttar Pradesh and Uttarakhand, in particular, having boosted the market sentiment.

“The third quarter earnings have indicated that the impact of demonetisation was limited. Going forward, structural improvements and reforms, implementation of GST (goods and services tax), and corporate earnings growth might determine the amount of investments FPIs make in our markets,” said Ravi Gopalakrishnan, head, equities, Canara Robeco MF.

Indian equities have risen 17 per cent in FY17 and are expected to go further. Morgan Stanley, the foreign brokerage, recently raised its base case December 2017 target for the benchmark BSE Sensex by 10 per cent, to 33,000.

“Net demand for Indian equities is rising rapidly, implying the potential for a valuation overshoot. Valuations look reasonable versus history, emerging markets and bonds.

The rising demand for equities from domestic households and potential M&A (mergers and acquisitions) activity could take multiples higher in the coming months. Domestic investors are already significant buyers of Indian equities and corporate buying is adding to this demand,” say Morgan Stanley equity strategists Ridham Desai and Sheela Rathi.