FIIs finally turn positive on Indian equities

March turned out to be the first month in the current calendar year when Foreign Institutional Investors (FIIs) money flow turned positive and in March they showered over ₹7,936 crore into the Indian equity market. Though FIIs remained cautious in FY23 by pulling out ₹37,632 crore from Indian stock market, the outflow is much less than last fiscal's record outflow of ₹1.4 lakh crore. On the last trading day of fiscal 2022-23, the Nifty 50 Index closed in green by notching a gain of 279 points or over 1.63% and ended fiscal FY23 at 17,360.

Historically, there were four instances when FII flow crossed ₹1 lakh crore in a fiscal. In 2010-11, FIIs invested ₹1.1 lakh crore, in 2012-13 FII inflow was ₹1.4 lakh crore, in 2014-15 FIIs poured ₹1.11 lakh crore, while Indian stock market received highest FIIs inflow worth ₹2.74 lakh crore in 2020-21. In the next fiscal (FY22), FIIs withdrew a record investment of over ₹1.4 lakh crore from the Indian market.

On the back of FIIs pulling out money from the Indian stock market, the MSCI India Index gave a negative return of 0.74% in the last one year (till Feb 28). With 113 constituents, the MSCI India index covers approximately 85% of the Indian equity universe. Reliance Industries, Infosys and HDFC are the top three constituents of MSCI India Index with weights of 10.15%, 7.19% and 6.46% respectively.

Currently, China, Taiwan, and India are the top three countries in MSCI Emerging Market Index with a weight of 32.11%, 15.26% and 13.23% respectively. Emerging Markets have outperformed Developed Markets since the MSCI EM Index inception in 1988 mainly on account of turbocharged growth of China. China weight in MSCI top at 43% in 2020 but after the pandemic it lost 10% in the Index.

Foreign funds remained bearish for the last one year on emerging markets as rising interest rates in western world are making US treasuries and money market funds a much better option than emerging market equities that are considered risky by FIIs. In the last one year (till Feb 28, 2023) MSCI Emerging Market gave a negative return of 6.64%. As per MSCI website, currently $13.5 trillion in Asset Under Management (AUM) is benchmarked to MSCI Indexes. Also, 1,300 equity ETFs are based on MSCI Indexes.

Why do we talk about FIIs flow?

Many Indian investors, whether retail or Domestic Institutional Investors take validation from FII flows. Many investors believe that FIIs know more than domestic institutions and retail investors.

Moreover, Foreign Institutional Investors' exposure in Indian equities reduces cost of capital for promoters. Another significant contribution from FIIs is that they bring international perspective in equity valuation and guide Indian retail investors and Domestic Institutional Investors on valuation. In the past one year, FII selling can be attributed to macroeconomic factors such as the rising US10 year bond yield, depreciating emerging market currencies against US Dollar and spiking crude and commodities prices.

Usually, FIIs turn to Emerging Markets when the US bond yields are low but when 10 year yield starts inching closer to 3% is when investors get jittery and would park their money into fixed income.

On the back of high GDP growth and plethora of quality companies with consistent earnings growth, the Indian equity market usually got higher multiples than Emerging Market. Prior to the Russia-Ukraine war Indian markets were trading at a premium to Emerging Market. MSCI India's one-year forward PE was trading at 24 times against 13 times for MSCI EM, implying a premium of 88% at the end of January 2022, a way up than its historical average of 46%. The valuation gap between MSCI India's one year forward PE and MSCI Emerging Market's one year forward PE reached 110%, the highest valuation gap ever in October 2022. Since then the gap has narrowed due to rising interest rates in the U.S. that prompted FIIs to sell Indian equities and park capital in U.S. treasuries.