However, the consensus China trade did not last long as China’s growth began to slow down. Meanwhile, in stark contrast, India received a significant boost from a better-than-expected GDP growth rate of 6.1% in Q4, surpassing the consensus forecast of 5%. This caught the attention of the FIIs, leading them to reassess allocations and shift flows into India.
While this backdrop of the current bull run in Indian markets has been widely debated, what remains unknown is the ongoing shift in both domestic and FII flows. It is this topic that we aim to explore and unravel in this column.
Let’s turn our attention to the domestic flows, where the evolving story is a lot more gripping and captivating.
In a reflection of the changing landscape, domestic flows no longer play second fiddle to FII flows like they used to a few years back. With the growing financialization in terms of a shift in savings from physical to financial assets structurally, domestic annual flows into equities have the potential to overshadow FII flows, and as a result, can emerge as the dominant force in shaping the Indian markets’ trajectory in the coming years. Here is the data point that will be a revelation to many in this context.
Domestic equity AUM which includes equity MF, DIIs like insurance, banks, and pension funds, currently is 550 billion odd. FIIs overall equity AUM is around 586 billion. The difference, which was close to about 140Bn+ dollars two years back, has now narrowed sharply to around 35 billion dollars.
This is because of the surging domestic flows on growing financialization. Annual domestic flows, which used to be less than 20 billion dollars a few years back, have significantly gone up to over 30-35 billion+ over the last two years. Currently, household savings in equities are less than 10% of their overall financial savings, while in developed markets, it is around 40% or more. This suggests that there is considerable headroom for domestic flows. Given this, it is a question of time before the domestic equity AUM outpaces the FIIs in a convincing manner.
Fortunately or unfortunately, this development may have some unintended consequences for the volatility in the Indian markets. In periods of massive FII pull-outs, one may not see deep corrections as witnessed in previous cycles because of the growing domestic support. One saw the early evidence when the Indian markets went through a shallow correction in the 1st half of 2022 when FIIs pulled out a massive 28 billion+ dollars in just six months of 2022.
On the other hand, when FIIs rush in, Indian markets are likely to overshoot (unrealistic valuations) as we are witnessing now because of the combo effect of domestic and FII flows. This will be an emerging challenge for value investors as cycles would become less vicious and more virtuous. This, of course, may not apply during periods of global accidents and global crises when markets may go through deep cracks.
On the other side of the fence, we have another interesting structural shift unfolding in global flows. It is well known that the concept of China+1 in terms of supply chain diversification gained significant traction after the pandemic exposed the risks of reliance on a single market. But what may be less widely known is the emergence of a similar China+1 play in portfolio allocation among global money managers. This primarily refers to the shift in investment strategies and asset allocation made by global managers to reduce the exposure to China as a measure of geo-political risk mitigation.
Global Investors are increasingly tracking MSCI-ex-China. A Reuters study shows a massive jump in assets of EM mutual funds and ETFs that exclude China as US and European investors are more wary of having exposure to China. Refinitiv data shows China-focused MFs suffered a net outflow of 674 million dollars in the second quarter of this year, while, in contrast, nearly one billion went into EM ex-China mutual funds.
Bloomberg data of equity flows into EMs in the second week this month (July 10 to 14th) shows the US ETFs favored India stocks the most among EM peers and invested 637 million dollars and around 1/3rd of it went to China. Though this is for a short period, this does point to where one is headed. Looking at another data point, China’s weight on the MSCI EM has reduced sharply to 29.55% from 38.7% in 2020, whereas exposure to India has increased from 8.3% in 2020 to 14.63%.
As a result of this diversification from China, Indian markets are witnessing a sharp surge in FII flows. In just three months, over 16 billion dollars have flooded into the Indian markets. For the calendar year, it is over 14Bn dollars and counting (adjusting for the outflows in the Ist quarter).
As a result of the aforementioned structural shifts in both domestic and global flows, along with India’s relatively stronger macroeconomic position, Indian benchmarks, which have been stagnating within a range for over fifteen months, experienced a sudden surge in momentum, leading to a breakout in benchmark indices to new all-time highs.
This surge was bolstered by the robust performance of the Nasdaq and S&P in the global markets. This positive sentiment from these global indices had a timely and amplifying impact on the domestic markets, fueling optimism in all directions.
More importantly, the structural trends in flows explored in this column are something real that is here to stay and gain more traction in the coming years. It is essential for investors to understand this, and accordingly, they should recalibrate their strategies and expectations on the emerging valuation landscape, which could see a profound change in the coming years.
(ArunaGiri N is the Founder CEO & Fund Manager of TrustLine Holdings)
