A paraphrased adage that goes “too sweet to spit, too bitter to swallow” perhaps best describes the current position of various foreign fund managers on Indian stocks. For many of them, India is a fascinating upcoming alternative to the slowing and ageing economic giant of the region – China.
Superior growth parameters and a potentially flourishing domestic market are factors delighting long-term investors. At the same time, they are hesitant to go all out on the country’s stocks at this juncture as over-ownership of equities and premium valuations are pushing many value-conscious money managers to delay their purchases here.
Foreign investors must be categorised on the basis of their approach and strategies. Those with a more active style of investing such as hedge funds, proprietary desks and ETF investors move in and out of stocks based on parameters such as currency, momentum, extent of ownership among others. The other broader category – long-term investors – buys and holds Indian stocks, mostly blue chips, for years together. Both these categories have influential roles to play in Indian equities.
In the ongoing stock market sell-off, it’s the hedge funds, prop desks and ETFs that are pulling money out of India. A lot of it is part of their reduction of exposure to Emerging Markets, including India, with risk sentiment taking a hit on account of the surge in US Treasury yields to 5% and tensions in the Middle East. A lot of this hot money will mostly return soon after the unease over the US bonds subsides and when stocks are available at lower levels to play the next level of the momentum game.
The other section – long-term fund managers – are the ones who have mostly been sitting on the fence when it comes to big allocations to India. Many of these fund managers are super bullish on India for the longer term but have not been able to convince themselves to put in a lot more than what they already have, other than place marginal or one-off bets.
One widely known reason for that is India’s share valuations. According to JPMorgan, India’s estimated Price to Earnings (PE) ratio is currently at 20.2 times, 15% higher than its 15-year historical average. India’s valuation premium to Emerging Markets (EM) remains wide at 77% currently as against 51% historically. In short, Indian shares are rich by most parameters.
The other key factor is their over-ownership of domestic blue-chip stocks. Most of the large foreign fund managers already hold loads of India’s creme de la creme companies – HDFC Bank, ICICI Bank, Infosys, TCS, HUL and the like – making it difficult for them to own more of the Nifty 50 companies.
The bigger issue here is that several fund managers do not have the confidence to plough in big money beyond the top 50 or 70 stocks because of liquidity concerns. For instance, a big global fund wanting to deploy $3-5 billion in Indian equities immediately would be forced to buy the same set of blue-chip stocks as the smaller ones would not meet their crucial liquidity criteria, which is key to their exit strategy in the event of the outlook turning adverse. With most top liquid large-caps already trading at premium valuations, fund managers are wondering whether this is the right time to come in. At the same time, they are unwilling to slash their exposure to what is considered one of the most promising economic growth stories of the decade ahead. Being underweight on Indian stocks is something that many overseas portfolio managers are unwilling to risk.
Historically, foreign investors always could buy and sell at will as a strong market decline allowed them to buy shares at cheaper valuations. In the past three to five years, strong domestic participation has denied foreign investors such opportunities, barring the Covid-induced sell-off.
With domestic investor appetite showing no signs of waning and big foreign investors focusing on the public market waiting on the sidelines, it might require some push by the government and the regulator to boost supply of shares. The government has already kick-started the investment cycle, which is the natural progression for more companies to raise money from the market. But that usually takes time. While the market has been flooded with smaller share issuances, the larger ones have largely been missing. Till the time the market becomes deeper, hot foreign money could continue to dominate flows into and out of Indian equities.
