FIIs pour money into Indian markets. Should you? - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

FIIs pour money into Indian markets. Should you? 

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In this issue:
» India among top 16 investors in US bonds
» Will Indians invest more in financial assets?
» Infra firms have plans to hit the IPO market
» Why are both stocks and bonds moving up?
» ...and more!

That foreign institutional investors (FIIs) play a big role in determining the movement of the share markets in India is a fact well known. One need look no further than the 2008 crisis which saw Indian indices plunge on account of huge FII outflows. The reverse also holds true. In the last few months, India has become a hot destination for FII money. Indeed, an article in the Economic Times states that foreign flows may top US$ 50 bn by 2015.

So among the BRIC countries, what has led to FIIs making a beeline for India? One is on account of geo-political tensions in Russia. Because of this, a lot of money is being pulled out of Russia and is finding its way into India. Continued low interest rate policies in the US and Europe have also compelled FIIs to look for better yields and hence the preference for emerging markets including India.

Interestingly, the scenario was quite the opposite in early 2013. Then, India was considered fragile because of high fiscal deficit, firm inflation, slowdown in economic growth and weaker currency.

There has been no drastic improvement at the ground level. And yet FIIs have continued to pour money into the Indian markets largely based on expectations that the Modi government will deliver plenty when it comes to reforms and development. So the rise in the BSE-Sensex so far has largely been a rally based on expectations rather than improving fundamentals.

The government has emphasised its intention of bringing the deficit as well as inflation down. As far as the fiscal deficit is concerned, it has set for itself some ambitious targets till FY17. Bringing inflation down would also pose a challenge. This is because food prices so far have been the major culprit. And as we pointed out in yesterday's edition of the 5 Minute Wrapup, the real cause of food inflation could largely be attributed to system of minimum support prices (MSPs) being misused. So for the current government, bringing inflation down is not something that can be achieved by short term measures but would involve considerable thinking on how to bring about structural changes.

Should the Modi government fail to deliver, it will hardly be surprising if these very FIIs withdraw money once again in droves. That is why it is important for investors to not base their investment decisions on FII activity but rather stick to the principles of value investing if they want to build a profitable stock portfolio. This is because FII activity is largely based on the availability of cheap money. But value investing is all about finding good businesses, with strong managements where there is enough margin of safety in valuations. Only such a disciplined approach to stock picking will ensure long term wealth irrespective of what the FIIs choose to do.

Do you invest in Indian equities based on what the FIIs are doing? Let us know in the Equitymaster Club or share your comments below.

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01:46  Chart of the day
Indian investors - primarily the country's central bank, the RBI - have been lapping up US government bonds of late. During the month of June 2014 for instance, the country's investments in US government bonds stood at US$ 73 bn. As today's chart of the day shows, India has invested a total of US$ 146.2 bn in US treasury bonds, thereby including it in the top 16 lenders (to the US) list.

Considering that a large part of the bank's forex reserves are held in dollar currency, it would make sense to invest into the US bonds, as the market is way more liquid and relatively safe as compared to bond markets of other developed nations.

Readers would do well to recollect that in the second half of 2013, Indian currency had taken a terrible hit. As a last resort, the RBI intervened by selling dollars which caused the forex reserves to dip substantially. However, this time around it seems to be taking a proactive strategy. Taking advantage of the strong FIIs in the country, the central bank has been increasing its forex reserves, which stand close to US$ 320 bn; a fifth of this amount is believed to be invested in US government bonds.

India is one of the largest lenders to the US

The common link between Indian and Chinese households is that by nature both are good savers. Both the economies have not just seen their young population grow but also save more. And ironically the households in both economies dominate the global demand for gold. So over the past decade, it is gold as against financial instruments that have seen most of incremental savings flow to. In fact at less than 10% of household investments, Indian households are amongst the ones with lowest exposure to equity markets. Bank FDs are preferred. However, with nearly a third of the economy still under banked, gold and real estate remain the prime areas of investment. It is expected that with banking reforms and economic growth, the trend should reverse. Also, as asset classes like FDs and equities offer attractive returns, investors should get more confident about them. More than anything else, higher financial literacy, improved transparency and better regulation of the capital markets are necessary to ensure increased exposure to financial savings by Indian investors.

Most listed companies have announced their results for the quarter ended June 2014. As per an article in Wall Street Journal, BSE-Sensex companies have seen their profits increase by 19.3% year-on-year (YoY) during the quarter. Over the last six years, there have been only two quarters when the profit growth was higher than this. So is the recent improvement in results attributable to Modi's coming to power? We don't think so. The Modi government came to power only in the second half of May 2014. The effect of its governance and business-friendly policies will be seen only in the due course of time.

Then what is it that drove profit growth for Sensex companies during the quarter? For one, it is certainly not because of recovery in domestic demand. One of the key factors that have driven profit growth for export-oriented companies is the weakness in the Indian rupee against the US dollar. Other factors that have contributed to the profit growth are favourable commodity prices and debt restructuring. Some companies that were overburdened by debt have sold off assets to restructure their debt to manageable levels. So all in all, the improved performance is not because of the new government or any significant recovery in the economy.

The Indian markets have scaled new highs on the back of huge FII investments. It is inevitable that in such euphoric phases, there will be a flood of public issues. We had cautioned investors regarding an IPO boom about to hit the markets. Sure enough, several companies are lining up with their offers to the public. The flavor of the season seems to be infra firms. This is not surprising. The government has promised to revive the sector. Large firms in this space like GMR Infra and JP Associates, have already raised funds via the QIP route. Smaller firms are now following suit. As per an article in Livemint, at least 10 infra firms have plans to hit the IPO market in the next 6-12 months.

We believe investors should be extremely cautious regarding these issues. Many of these infra firms are laden with debt and will use the IPO funds to pay down the same. Also, these Upcomo IPOs will be a perfect chance for private equity (PE) firms to exit these companies. It must be kept in mind that many of these PE firms had invested in infra companies 3-4 years ago. They could not exit due to the poor market conditions. Now with the market having revived, they will look for premium valuations to make their exit. Investors will be well advised to assess each company on its merits and invest only if the company is not being valued richly at the time of the IPO.

An abnormal event this past week caught the attention of noted market expert Mohammed El-Erian. As per him, prices of all kinds of assets, from safe government bonds to risky stocks, went higher. In a normal world, stocks and bonds mostly tend to move in opposite directions. Simply because stocks are a bet on an improving economy whereas rise in bond prices signify troubled times ahead. Therefore, if both these asset classes are moving in one direction, investors in one of these assets have to be wrong.

So, which asset investors are right here? As per El-Erian, it is indeed the bond investors. And the reasons are not hard to find. Bond investors are not only more risk averse but possess a better understanding of the macroeconomic picture. Equities on the other hand can go up even when the underlying fundamentals are not that great. For example, stock buybacks, which are nothing but a manifestation of cheap money printing, can also make stock prices go up. Consequently, it will be better if investors put more faith in bond investors and brace themselves for a market sell-off.

The Indian stock markets continued to trade firm in the afternoon trading session. At the time of writing, the BSE-Sensex was trading up by 72 points (+0.3%). Barring IT, all the sectoral indices were trading in the green. Auto and realty stocks were the biggest gainers. Most of the Asian markets were trading in the green led by Taiwan and Japan. Even European markets have opened the day on a firm note.

04:56  Today's investing mantra
"Proper accounting is like engineering. You need a margin of safety. Thank God we don't design bridges and airplanes the way we do accounting." - Charlie Munger
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2 Responses to "FIIs pour money into Indian markets. Should you?"


Aug 20, 2014

I do operate in the stock markets , keeping in view FII movements. However I sell when they are buying and I buy when they are selling. I however buy and sell only in large or small cap blue chips , because that is what FIIs do. Of course I am a very small man and my buying and selling is not more than 20K on a single day and I do not buy and sell every day.



Aug 19, 2014

I have interesting aspect of Stock market when you have to Sell and wait on the sidelines. It is "When your mother-in-law starts taking about Stock Market, it is time to get out of Stock Market". It is true, though it might sound funny.

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