CIRCUIT BREAKER. Do stocks have a domestic safety net?

For long, Foreign Portfolio Investors (FPIs) have held the Indian stock market in their pincer-grip. This is why the Sensex does a nervous jig every time an irrelevant event unfolds on the other side of the planet, whether it is Greece dodging its lenders or Janet Yellen dropping vague hints about US rates.

This ultra-sensitivity to global cues has heightened the impression that the Indian stock market is a dangerous place to be, where liquidity-driven mood swings matter more than fundamentals of the economy or companies.

But recent events suggest that the Indian market could be becoming more resilient to global cues. In the China-triggered market collapse this August/September, India fared much better than many other Asian and BRIC markets. Indian indices now sport a six-monthly loss of 5 per cent against 11-12 per cent for most other major markets. How did this come about?

Data from the depositories show that FPIs did indulge in a selling binge after the Chinese market crash in August/September. They pulled out ₹19,800 crore in August and another ₹11,200 crore in September on a net basis from Indian stocks. These were the highest level of FPI sales since January/February 2008 (when they sold ₹33,500 crore over two months).

But the difference this time around was that domestic institutions were able to step into the breach. In August/September 2015, domestic institutions bought ₹26,700 crore (net) worth of stocks, absorbing nearly 85 per cent of FPI sales by value.

Domestic institutions were buyers in January/February 2008 too, but their purchases accounted for just 60 per cent of the net sales by the FPIs then. This time, with domestic institutions stepping in with large buy orders as soon as foreign investors hit the sell button, domestic stock prices found a floor pretty quickly.

The buying by domestic institutions was no charity to rescue the markets. Domestic mutual funds reported a big surge in inflows into their equity schemes from retail investors both in August and September. It was this new retail money which helped domestic money managers step into the breach, when foreign investors sold. The newfound clout of domestic institutions can in fact be traced to a change in domestic investor behaviour in the last couple of years. Two specific data points tell the story.

For one, the latest shareholding patterns of the NSE-listed companies (end-September) show the domestic ownership of equities is getting increasingly routed through professional managers.

Currently, FPIs own about 21 per cent of all outstanding stock (by market capitalisation) on the NSE, while domestic investors (both institutional and retail) own 19 per cent. That 19 per cent consists of insurance companies and mutual funds with 5 per cent each, while retail investors hold about 9 per cent directly in stocks. (Promoters hold 47 per cent and the residual 3 per cent is with companies, NRIs and others).

In 2005, retail investors directly held 11 per cent in stocks and routed just 3 per cent through mutual funds, with another 5 per cent via insurance companies.

Thus, trends in the shareholding patterns of Indian companies show that retail investors have steadily reduced their direct holdings in stocks in the choppy markets of the last six-seven years, while parking more of their equity money in mutual funds.

This propensity of retail investors to go to professional money managers instead of directly dabbling in stocks is a positive development for the stability of the markets. While individual investors may be prone to sell in a panic when the going gets tough, professional money managers can be expected to take a more considered view of valuations before taking buy or sell decisions.

Given that a majority of equity funds in India beat the indices and have delivered good long-term returns, this institutionalisation of retail holdings, should lead to a better investor experience with equities as an asset.

Two, apart from retail investors, domestic institutions which were hitherto allergic to equity risks are also being pushed by the Centre to allocate more money to equities, to pep up their returns. This has added to the money power that domestic institutional investors have in the markets.

For instance, the Employees Provident Fund Organisation recently flagged off its stock market investments promising to park at least 5 per cent of its annual inflows (roughly ₹1 lakh crore) in equities. After new tax breaks in the budget, the National Pension Scheme has become quite a hit with investors and now manages a ₹1 lakh crore corpus. The pension regulator in now considering a proposal to allow the central and state government employees in the NPS to up their equity allocations to 50 per cent. If this move takes off the NPS can turn into a prolific buyer of Indian equities too. Market-linked plans of insurance companies, which had lost investor favour are attracting new inflows in this bull market too, with private sector insurers reporting that 60-80 per cent of their new business in the first half of this fiscal came from ULIPs.

All these flows, on top of the ₹1 lakh crore of new investments that equity mutual funds have attracted in the last one year, add up to a sizeable domestic kitty to be deployed in stocks. Incremental flows of ₹1.2 to ₹1.3 lakh crore ($18-20 billion) annually into equities is in fact more than sufficient to provide a counter-point to FPI action in Indian stocks. In the last ten years, FPIs have poured only ₹50,000-₹60,000 crore into Indian stocks annually, on an average.

So does this mean domestic stock markets are now immune to FPI selling? Not entirely, on two counts.

For one, it is not just the firepower that you have that matters in the stock market, it is your nerves too. Given that the FPIs own over a fifth of all outstanding stock in the markets, concerted selling by them can still lead to big dents in stock prices. Therefore, it will take a great deal of conviction on the part of local investors to keep buying at lower prices, if FPIs are on a selling spree. This will call for domestic money managers to take a contrarian view of the markets and the economy from the FPIs, which may not be possible all the time.

Two, for domestic institutions to counter FPI selling, they will have to receive new retail money every time market tanks. This calls for a big change in retail investor behaviour. Though retail investors have made a comeback into equities in the last one year, we cannot ignore the fact that they have re-entered stocks only after returns improved due to the Modi-induced rally. In the years from 2009 to 2013 when stock prices were flat-lining and valuations were much cheaper, equity products found hardly any takers.

It is therefore early days to celebrate the Indian market’s newly won immunity to FPIs. It all depends on whether retail investors continue to keep faith in equities if the markets enter a particularly volatile phase. With the Chinese markets still wobbly and the US Fed still making threatening noises, we will have plenty of opportunity to watch this war of nerves in the coming months.

COMMENT NOW