Desi money to fuel stock market

Observers of the Indian stock market were baffled by the manner in which it defied gravity in 2017, hitting new life-time highs every other day. And this was despite a host of negatives — an economy reeling from the demonetisation blow, the GST roll-out destabilising businesses and corporate earnings further, banking sector’s growing pile of stressed assets. The performance of the Indian market in 2016 was also on similar lines with stocks defying the odds.

This trend suggests that there are investors who believe in the long-term prospects of Indian stocks and are willing to continue investing despite the short-term noise. Our analysis of the net annual investments made by foreign investors and mutual funds in Indian stocks since 2000 shows that the resilience displayed by Indian markets in the recent past is due to the growing clout of domestic investors. There is a marked shift in the composition of money flows into the Indian market since 2015, with domestic money overshadowing foreign money.

The beginning of this era of domestic money can be traced to 2014, around the Lok Sabha election. The optimism generated by the Modi-led government taking charge at the Centre coincided with high decibel advertising by the mutual fund industry asking investors to park money in MFs through the SIP (systematic investment plan) route. The SIP culture has now taken root and is showing a sharp growth. Coupled with money flows from insurance and pension funds, domestic institutions have been able to outdo foreign investors in equity inflows.

The good news is that this money will be less erratic when compared to foreign money flows. While the Indian stock market cannot remain insulated from volatility in global financial markets, the cushion provided by domestic liquidity will help us sail through turbulence relatively easily.

Domestic money to the rescue

The Indian stock market has largely been dependent on foreign portfolio money, ever since the market was thrown open to these investors in the early nineties. Relatively higher growth of companies in India resulted in foreign investors diligently buying Indian shares over the years, with their holding in Indian stock market increasing to ₹27.77 lakh crore towards the end of February 2018, accounting for around 20 per cent of Indian market capitalisation.

But the recent surge in money flows into mutual funds and insurance companies has resulted in equity assets of domestic institutions increasing to almost ₹18 lakh crore.

The point to note is that the share of mutual funds in annual incremental flows is far outstripping foreign portfolio flows since 2015. An analysis of net annual investment by mutual funds and FPIs into the Indian equity market since 2000 reveals that MFs were on the back foot until 2014, but they have taken over since then.

In the period following the sub-prime crisis, when investors pulled money out of MFs, funds turned net sellers in equity markets between 2009 and 2013, with the exception of 2011. FPI flows, on the other hand, were strong in the period following 2008, as increasing global liquidity, thanks to monetary easing by global central banks, resulted in a flood of FPI money entering India.

But the tables have turned since 2015. With the Federal Reserve beginning monetary tightening, global liquidity conditions became tighter. In 2015, while MFs’ net investment in the Indian equity market was ₹69,936 crore, FPIs invested only ₹18,608 crore. In 2016 and 2017, net investments by MFs were more than twice the amount pumped in by foreign investors. In 2018, too, mutual funds have been buying Indian stocks, even as the threat of a deeper correction looms over the markets.

What’s caused this turnaround in domestic fund flows? Is this likely to sustain?

 

 

Mutual funds ‘sahi hai’

The growth in domestic money in Indian markets has been led by mutual funds. A number of factors appear to have triggered this inflection point in mutual fund inflows. The foremost appears to be the wave of optimism that gripped the country in the run-up and after the 2014 general elections when the Modi-led NDA swept to power. The Nifty gained 78 per cent between September 2013 and March 2015. Expectation of a stronger economic growth and fast-paced reforms appear to have drawn investors to the stock market.

While equity oriented mutual funds, ETFs and ELSS schemes faced net redemptions in 2012 and 2013, there were net inflows to the tune of ₹53,193 crore in 2014 and a higher ₹96,389 crore in 2015. The inflows continued in the subsequent years and in the first two months of 2018, net inflows are already at ₹30,377 crore.

The campaign by domestic mutual funds asking investors to adopt the SIP route to investing in mutual funds also appears to have worked. According to CAMS, an RTA (registrar and transfer agent) that handles about 64 per cent of the mutual fund industry’s AUM (assets under management), monthly inflows through SIPs have been growing sharply since 2014. From average monthly flows of ₹868 crore in FY14, flows have increased to ₹3,593 crore in FY 18.

The other catalyst that made domestic mutual fund inflows surge is the hunt for higher returns by domestic investors. The RBI went on a rate-cut spree from 2015, slashing policy rate by 150 basis points over 2015 and 2016. With bank deposits getting increasingly tepid returns, investors began eyeing balanced and debt funds as alternatives. The RBI’s report on assets and liabilities of the household sector shows that bank deposits of households declined from ₹6.39 lakh crore in 2013-14 to ₹6.22 lakh crore in 2015-16. On the other hand, investment of households into stocks and mutual funds jumped from ₹18,900 crore to ₹41,317 crore in the same period.

With returns from gold and real estate also turning lacklustre in this period, investors would have found it easier to rely on the mutual fund route to earn better returns. Gold prices have been moving in a range between $1,100/oz and $1,400/oz since 2014, while real estate prices started looking up only in 2017.

Demonetisation in November 2016 was yet another factor that helped boost mutual fund inflows. The RBI report shows that currency held by households was distributed among financial assets such as bank deposits, mutual funds, stocks, insurance and pension assets in 2016-17.

 

 

Pension and insurance money

While mutual funds have tasted success in recent years in channeling domestic investments into the equity market, pension funds have been slow starters. Managers of pension funds have been reluctant to park retirement savings in the stock market. But the first step has been taken and this source has the potential to grow larger than MF flows over the next decade.

The Employee Provident Fund Organisation took the decision to invest up to 5 per cent of the annual incremental flows into the equity market in 2015. The EPFO has taken the ETF route to investing into the equity market and has mainly invested in Nifty, Sensex and CPSE ETFs through various fund houses. The total equity investment of the EPFO, up to March 2017, was ₹21,288 crore.

With the limit for investment now at 15 per cent of incremental flows, around ₹18,000 crore is expected to flow into stock markets through the EPFO in FY18.

Some funds parked in the National Pension Scheme (NPS) also find their way into the stock market. But the schemes for government employees mainly park the money in debt. The scheme for all private citizens allows them to park a part of their funds in equity. But the corpus of NPS in the equity market was only ₹4,000 crore as of December 2017.

Lack of awareness is currently impeding the expansion of the private citizen plan of the NPS. Fund charges are also pretty low (0.01 per cent), making it unattractive for asset managers. Once that is addressed, the equity corpus of NPS could grow further.

Money invested in Unit Linked Insurance Plans has also been fuelling the stock markets in recent times. With regulatory tightening and sound returns delivered by these funds in recent times, they have once again caught investor fancy. Equity assets owned by insurance companies hit a new record of ₹8.69 lakh crore in December 2017, with ₹2 lakh crore of addition to the equity AUM in that calendar year.

Will the flows sustain?

While the last three years have been very good as far as inflows from domestic institutions go, it is quite likely that these flows will only get stronger in the coming decades, providing a strong counter-party to absorb the sales of foreign investors. There are various factors supporting this.

One, the under-penetration of equity markets in particular and financial assets in general within India is the primary reason why money flow into equity from domestic sources can only go higher from these levels.

According to the RBI report of the household finance committee, under Prof Tarun Ramadorai, an average household holds 77 per cent of its assets in real estate, 7 per cent in other durable goods, 11 per cent in gold and the remaining 5 per cent spread over financial assets such as bank deposits and savings accounts, publicly traded shares, mutual funds, life insurance and retirement accounts.

Improvement in socio-economic conditions cannot take place overnight, but even if another 5 per cent gets allocated to financial assets over the next couple of decades, it will be large enough to buttress the stock market.

Two, the drive towards financial inclusion, with the opening of Jan Dhan accounts, providing pension schemes and insurance cover for the underprivileged will result in increasing the comfort level of the people with formal banking and investment channels. This can also aid equity inflows over the long term.

Three, the shifting preference towards mutual fund SIPs and ULIPs is likely to continue over the next decade as the urban working class with higher investable surplus grows more aware of the need for financial planning.

Four, the relatively better prospects of Indian equity in delivering superior returns when compared to other assets such as fixed income, real estate or gold over the long term and their ability to beat inflation on a sustained basis also makes the case for equity investing in India a sustainable one.

While stock prices in India will also correct with other emerging markets in times of global volatility, desi money will ensure that the corrections do not damage stock prices too much.

Foreign flows to turn erratic

As highlighted in the main story, foreign portfolio investors were the driving force behind Indian equity until 2014. But there has been a reduction in FPI flows since 2015 and this can be linked to the monetary policies of the Federal Reserve. Investors from the US bring in the highest amount of funds in to India — they held ₹9,72,591 crore of stocks towards the end of February 2018, accounting for 35 per cent of the total FPI holding in Indian equity.

It is for this reason that FPI flows into India are affected by Fed actions. As the Fed pumped in over $3.5 trillion worth of money in to the US economy through bond purchases between 2009 and 2014 and reduced its interest rates to close to zero, FPI flows into India also hit record highs. With the tapering of the QE program in 2015 and the gradual hike in Fed fund rate since December 2015, FPI inflows into India have declined.

With the Fed beginning its balance sheet reduction in October 2017 and on course to hike rates two to three more times this year, borrowing conditions in overseas markets are expected to tighten further.

But easy money policies followed by other major central banks can counter the Fed tightening to some extent.

For instance, the European Central Bank is continuing to maintain rates at close to zero. It has also stated that monthly asset purchase worth Euro 30 billion will continue until this September. The ECB also remains inclined to support growth through easy monetary policy for as long as needed.

The Bank of Japan is also continuing with its near zero interest rates, given the stubbornly-low inflation in the country and continues to pump stimulus money every month. The Bank of England has however begun raising rates, with the first hike done last November. Also, the Trump tax plan can increase the US deficit and help increase liquidity in US.

Besides central bank policies, benign growth outlook also supports global flows into emerging markets. According to the IMF, global growth has been good in 2017, due to upside surprises in Europe and Asia, making it revise its forecast for 2018 and 2019 higher to 3.9 per cent. Improving global trade, higher manufacturing output and the positive impact of the tax cuts proposed in US are other factors supporting growth.

The flipside is that steep valuation makes financial markets vulnerable to price correction and the trade war that is looming ahead has the potential to derail global markets.

While FPI flows can turn erratic in the coming months, desi money can act as a counter.

(With inputs from Dhuraivel Gunasekaran)

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