CIRCUIT BREAKER. Return of domestic money managers

Is the Indian stock market becoming immune to Foreign Portfolio Investor (FPI) action? Seasoned investors would probably have a good laugh at this claim, given how FPIs have been able to bend the Indian indices to their whims and fancies in the past. But it is a fact that recent bouts of FPI selling haven’t shaken up Indian markets as much as they used to, even three years ago. After a really long buying binge in Indian stocks between January 2012 and April 2015, FPIs indulged in a big-ticket sell-off between May 2015 and February 2016 in a knee-jerk reaction to the US Fed rate hike.

Though these ten months saw a net sum of ₹77,000 crore leave the markets by way of FPI withdrawals, the Sensex reaction to this was quite mild, with just a 15 per cent decline. Contrast this with 2008-09, when ₹73,000 crore of net selling by FPIs over a year saw the Sensex crash by 40 per cent.

The behaviour of mid and small-cap stocks, which have traditionally behaved like headless chickens in any major sell-off, has been even stranger. In the 2008-09 rout, the BSE Midcap and Small-cap indices had their bottoms drop out with losses of 55 per cent and 50 per cent respectively.

But the recent FPI exodus has seen the Midcap Index lose 8 per cent in ten months’ time and the Small-cap Index has got by with a 15 per cent decline.

This relative resilience of the Indian market — particularly non-index stocks — to FPI selling can be attributed mainly to the rising clout of domestic institutions in the market.

It was steady buying by domestic institutions such as mutual funds, insurance firms and pension funds that seems to have shielded stock prices from a major meltdown in the last one year. Data from the exchanges show that net FPI sales of ₹77,000 crore were more than met by the ₹84,000 crore of net buying by domestic institutions, in the ten months from May 2015 to February 2016. This shopping trip in equities was powered mainly by retail investors returning to their fold.

After cold-shouldering equity investments for a six-year span between 2008 and 2014, retail investors have been committing serious money to this asset class in the last two years. Equity mutual funds have seen two consecutive years of record inflows.

Thanks to this, and strong market performance that has expanded their assets, they now control a ₹5 lakh crore (as of July 2016) slice of the equity market capitalisation, compared to just ₹2 lakh crore five years ago.

Given the tendency of Indian fund managers to shop actively outside of the indices for their portfolio bets, a sizeable portion of this money has gone into mid-cap stocks, thus explaining the newfound mojo of mid-caps.

Insurers have seen subscriptions to their market linked plans pick up too and now manage over ₹5 lakh crore in equity money, up from about ₹3.3 lakh crore.

The National Pension System (NPS), which was a non-entity with ₹15,000 crore in assets in 2012, has been buoyed by tax breaks to emerge as an institutional investor to reckon with. In July 2016, NPS had ₹1.38 lakh crore in its kitty. Just a fifth of this is equity money, but with plans to allow government employees to hike their equity allocations, NPS will soon be a player of note in equities.

The ultra-cautious Employees’ Provident Fund Organisation (EPFO) has also been tentatively dipping its toes into equities too. After securing approvals from its trade unions, it invested just short of ₹7,500 crore in index stocks in the last eleven months. This is peanuts, both from a market standpoint and given the ₹1 lakh crore incremental flows that the fund receives annually. But talks are on for the allocation to be raised in gradual doses.

Adding up all these numbers still doesn’t take domestic institutions anywhere near the FPIs on sheer size. Number-crunching on the latest shareholding patterns (June 2016) tells us that FPIs presently hold 20.6 per cent of the total market capitalisation of the top 500 stocks, while domestic mutual funds and insurers hold a combined 10 per cent.

But there have also been two really important changes in retail investor behaviour this time around, which strengthens the hands of these local money managers.

For one, while previous bull markets have always had retail investors jump headlong into equities, this time is a little different. Instead of buying up penny stocks or subscribing to overvalued IPOs, most retail investors are playing it safer by handing over their investments to professional managers. The proof of this comes from the fact that while the direct retail ownership of equities has remained flat at 8 per cent for the last five years, retail money routed through vehicles mutual funds and insurance companies has risen from 8 to 10 per cent.

Two, instead of betting their shirt on one-off investments at market highs, retail investors are taking a phased approach to their allocations. Equity funds report that well over a third of their monthly subscriptions now flow in straight from the pay-checks of investors, by way of the Systematic Investment Plans (SIPs). Investments into market-linked insurance plans, the NPS and the EPFO are mainly in the form of monthly, half yearly or annual instalments.

These trends are healthy for the markets and ensure greater firepower (apart from fatter profits) for domestic institutional investors.

However, it also puts greater responsibility on them to deliver a good investing experience to retail investors, this time around.

For one, given the amount of time it has taken for small investors to regain faith in equities after the debilitating losses of 2008-09, these institutions can no longer afford to take foolish risks with retail money. Given how hard it has been to convince retail investors of the long-term potential of equities, this is not an opportunity that they can afford to mess up.

Two, with small investors clearly leaving the timing aspect to professionals, it is up to the latter to make sure that they take pro-active calls on the market and de-risk their portfolios in time if the markets get too hot to handle. Simply going with the flow and sticking to a safe consensus, will no longer cut it.

Most important of all, with retail investors increasingly taking the institutional route to equity ownership, it is time these institutions stopped being sleeping partners in the businesses they invest in.

So far, both mutual fund houses and insurers in India have been quite content to rubber-stamp management decisions in a majority of corporate actions. The occasional episodes of shareholder activism are left to foreign funds.

But as governance practices at India Inc are quite dodgy and moreover have a direct bearing on stock price returns, it is time domestic institutions did more to up the governance standards at India Inc, at least to protect their own interests. As Spiderman says, with great power, comes great responsibility.

COMMENT NOW