FIIs to Remain Bullish on India

We keep saying that the importance of FIIs reduces as domestic participation in Indian equity market increases. However, we don’t stop tracking FIIs activity, do we? There is a reason why we do so. Yogesh Supekar highlights FIIs’ participation and explains why FIIs cannot ignore a growth market like India

This November was one of the sweetest for equity investors as the BSE Sensex climbed by an impressive 3.24 per cent. Interestingly, these gains of little over 3 per cent pushed the BSE Sensex to all-time highs and made it a memorable month for investors. What is notable in the recent market moves is the huge inflow from FIIs. FIIs pumped in almost USD 3 billion in just 10 trading sessions by November 9, thus indicating huge interest in the Indian markets. While the FIIs have been net buyers in 2022, the question is whether they will remain net buyers in 2023 as well. 

To understand what can be expected of FIIs in 2023 it is important to note why FIIs showed interest in 2022 in the Indian equity markets. Some of the strong reasons why the Indian market was favoured by FIIs in 2022 include: 

1) Indian Markets’ Outperformance : When the global equity markets were trading with high volatility with a strong downtrend, the Indian equity market showed to the world what stable growth can do your portfolio returns. The table below highlights the Indian equity markets’ outperformance over the developed markets and other emerging markets. 

The relative outperformance of the Indian benchmark indices was the biggest trigger for the global investors to flock the Indian markets. The global fund managers could not miss the opportunity to generate alpha by investing in India when the other developed and emerging markets were generating negative returns.

2) Relative Strength of Rupee : One of the significant highlights of 2022 was the relative strength of the Indian currency. Even though the rupee weakened by ___ per cent in 2022 the slippage was much lower when compared to the other currencies. The table below highlights the relative strength of the rupee versus other currencies. The strength shown by the rupee implies prospects of higher returns on portfolio investments.

3) Corporate Earnings: The earnings, even though mixed this year, can be said to be inspiring given the volatile circumstances as several companies declared positive set of numbers along with strong guidance by the management. The strength and consistency in earnings was one of the factors that led to strong FII flows in 2022. 

Predicting FIIs Flows in 2023

After observing the FIIs’ flows and the reasons why they invested in the Indian equity markets in 2022, it is reasonable enough to assume that if similar triggers persist in 2023, FIIs should prefer Indian markets than the other emerging or developed markets. However, the market dichotomy is that it may outperform if the FII flows are positive and the FII flows increase as the market shows outperformance. This Catch 22 situation will always exist in the market and hence it is always challenging to predict both the market direction and the FIIs flow. 

To estimate whether FIIs will continue to buy in the Indian markets we will have to look at the global market setup as we enter 2023. The outlook for the global markets will be the key in assessing FIIs flow in 2023 in the Indian markets. Global economic growth is expected to slow down – there is no doubt about that. The estimated global economic growth in 2023 is ~2.6 per cent. There is a consensus of Europe being in deep recession and the US expected to face recessionary environment in 2023. There is no clarity on whether the recession in US will be deep or just transitory in nature. 

The length of the recessionary environment and the depth as well will determine the equity market moods in both US and the developed markets. That said, the recession in global economies, especially in the US, can be expected to be a positive for the Indian equity markets as we can expect more fund flows in 2023 seeking stable returns. This we can say because India is expected to deliver 6 per cent plus GDP growth and is touted to be among the fastest growing economies in the world. Yet, problems in the developed world may aid fund flows to the stable outlook of the Indian equity markets in 2023. 

A sustainable recovery in 2023 in global economies is also not ruled out if we look at the scenario with optimism. A point of view that is widely accepted is that the investors may continue to see pain until mid-year. Another emerging consensus amongst the experts is that the timing of the relief is tied to the actions of the central banks. So, it may not be speculative to say that the market mood for 2023 may largely be influenced by the decisions and announcements made by the central banks’ the world over. Investors will thus have to focus on the central banks’ actions along with the earnings and inflation data. 

Protect your Portfolio
The year 2023 will introduce a ‘new normal’ higher volatility environment that should still provide opportunities for equity investors, but it will also likely feature deeper draw-downs and shallower recoveries. Such an environment calls for actively managing the portfolio risks. Thus, investors will have to adopt portfolio protection strategies as well. 

What is FII?
A foreign institutional investor (FII) is an investor or investment fund registered in a country other than the one it is investing in. Primarily, institutional investors include those investing in hedge funds, insurance companies, pension funds and mutual funds investment. The term is very common here in India and hence refers to outside companies investing in the financial markets of India. In addition to the types of investors above, others include banks, large corporate buyers or representatives of large institutions. All FII activities take a position in a foreign financial market on behalf of the home country in which they are registered. 

FII activity in Futures and Options (F&O)

The role foreign institutional investors (FIIs) play in futures and options (F&O) is critical for Indian markets. FII statistics are crucial in predicting market undercurrents; therefore, many traders and investors closely monitor them. 

Monthly returns are the main focus of F&O transactions. Each tiny piece of negative news leads to unwinding and vice versa. Traders also watch when FIIs are long with large positions in addition to monitoring at leverage levels. The greater returns are one of the main factors contributing to the increase in FII activities in the F&O market. FIIs, who are primarily based in Europe and the US, perceive profitable prospects. When compared to the returns on their domestic fixed-income market, these returns are significantly larger. 

The increase in FII activity in the F&O segment is also due to the lack of depth in the cash segment, which is not large enough to absorb large volumes. Thus, FIIs have raised their game in the F&O segment rather than buying heavyweights in the cash market, backed up by significant holdings in most index heavyweights from the banking, software, and automobile sectors. Indian markets would have been more volatile if not for the increased activity in the F&O segment. 

FII Activity

Investing in equities becomes tricky at times as screening stocks for further analysis requires due diligence. However, tracking what the big players are doing, can prove to be a good starting point. Hence, analysing the Foreign Institutional Investors (FIIs) activity is a sensible thing to do. FIIs being one of the big players in the market, the buying and selling done by them do impact the overall market. In the last quarter, on a net basis, FIIs were net sellers to the tune of ₹ 2,850.39 crore. However, still there were stocks that witnessed a positive change in holdings.

The above table shows the change in FII holdings in the last quarter in Nifty 500 stocks. PI Industries, Can Fin Homes Hinduja Global, and Triveni Turbines were the top picks from FIIs from the Nifty 500 universe.

The above table shows the top five sectors witnessing heavy FII activity in the month of November 2022. As can be seen, Financial Services, FMCG, IT, Automobile, and Consumer Services are the sectors in which FIIs have invested. Having said that, sectors like Consumer Durables, Power, Telecommunication and Textiles experienced net selling from FIIs. 

The talk is not going to be is it going to be a 25-basis-point hike or what else. It's going to be when are we going to decrease the rate? That may come as early as the spring

-Jeremy Siegel
Russell E. Palmer Professor of Finance at the Wharton School 

The near 20 per cent appreciation of the US dollar in 2022 has also intensified the global growth challenge and may expose unanticipated vulnerabilities

-Lori Heinel
Global Chief Investment Officer State Street Global Advisors. 

Having a certain kind of temperament is more important than brains. You need to keep raw irrational emotion under control. You need patience and discipline and an ability to take losses and adversity without going crazy. You need an ability to not be driven crazy by extreme success.

-Charlie Munger
Legendary American Investor 

Conclusion

It is a no-brainer to understand that the Indian macro situation is going to be robust when compared to the rest of the world. With the kind of political stability India offers along with the focus on manufacturing sector that benefits from the China Plus One phenomenon and the PLI schemes introduced by the current government, we are witnessing a huge capex cycle in India. The expansionary fiscal policy as seen in record capex by the government indicates the bold and aggressive stance taken by the government in uncertain times. Usually, such activities can be expected to boost economic growth prospects and invite private players to join the momentum of increasing capex in the country. 

After a long gap we are witnessing some green shoots in private expenditure in India. Given the strong economic condition and the backdrop of expected recessionary trends in the western world, fund flows to Indian shores are a given. However, the risk remains on the valuation front and this may escalate if the corporates do not deliver on the earnings’ growth. It is widely expected that the aggressive rate hikes the world over will show their negative impact in the coming quarters for the corporates. Thus, it is generally advised that only those quality companies with proven business models should be a part of the core portfolio. Especially those companies that can absorb the pricing pressures and, even better, pass on the pricing to the end user are likely outperform in 2023. 

Banks fit perfectly in this theme of investments in 2023 as the rising interest rates help banks deliver better margins given that the floating rates of the loans are usually passed on to the end user while the deposit rates are increased with a lag. This assists in improving the spreads for the banks and report healthy profits. The positive momentum for the banks may continue in 2023. This could also be the reason why FIIs are bullish on financials and banks. We have seen good accumulation by the FIIs in 2022 in financials and banks along with select automotive sector stocks. 

In 2022 we saw a trend of ‘buy India, sell China’ and this trend in the short term can reverse as the valuations start looking attractive in China and a little unsustainable in India. However, over a medium to long term the trend can be expected to be in favour of the Indian equity markets. While tracking FIIs flows one must also consider the derivative action as FIIs are more influential in the derivatives markets with volumes picking up in the derivatives section. FIIs’ long build-ups and short build-ups can be used to determine the trends in the near term. 

Hence, investors while studying the FIIs flows should also keenly track the FIIs action in the derivatives segment to understand the near-term trend. After all, the summation of near trends is what shapes the long-term trend. Usually, to understand the sectoral outperformance one can track which sector is attracting maximum long build-up and where the shorts are getting built. Track FIIs flow in both the cash segment and the derivatives segment to get a better view of the market trends and opportunities. Given the concern in the global economy, domestic-oriented companies will be in focus with the manufacturing sector looking ripe for investments. 

The support provided by the current government is unprecedented and the sector will continue to attract investments from both the institutional and domestic investors. As India continues to offer best alpha generating opportunities, it will attract monies in 2023. The journey however will be volatile as uncertainties persist. The geopolitical situation continues to put pressure on commodity prices even though the easing of supply is expected to bring inflation down in 2023. For investors, the best news ever that can be, given the uncertainties, is the peaking of USD and inflation and hence the expected reduction in interest rates, which may happen in the second half of 2023. 

History has shown us that such an environment is most conducive to invest in equities. The market being forward looking, the stock prices may not wait until the US Federal Reserve starts to announce the softening of the interest rates. The equity prices will start moving upwards much before the interest rates reduction is announced. Investors will most likely begin to price in the next phase of the economic cycle before the economic, earnings and the job market data begins to show signs of recovery. The first half of 2023 which is expected to be volatile may thus provide an excellent opportunity for investors. The Indian equity markets’ divergent trend may not remain as strong as seen in 2022. However, the Indian equity market is not significantly expected to underperform and in fact is expected to continue to attract investors.