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DII f(PI)lows – trend or just a bend??

FPI flows have historically had a direct co-relation with the index movement.

Look at the chart below.

Flow Impact - YoY

The chart clearly depicts the co-relation of FPI flows with that of the movement of the broader index (Nifty). The pattern seems to have played out even at instances where the FII selling (or buying) was absorbed (or being matched in the opposite direction) by the DIIs. For instance, in CY15, DIIs ended the year with a net buying off Rs. 640 bn; ~4 X that of what the FPIs sold during the year! However, this didn’t prevent Nifty from slipping by ~4% (from 8282 to 7946).

CY16, however, reflected a different picture. While FPIs continued their selling spree, ending the year with net sales of ~Rs. 118 bn, the index ended the year with gains of well over 3%! This debunks the inverse correlation (Index with FPI flows) theory that has been prevalent thus far. This phenomenon has led to thoughts of, probably, a structural trend being established in mutual fund inflows, which not only neutralizes any FPI outflow but also help in driving the markets higher on its own.

Flow Impact - MoM.png

A closer look at CY16 flows reveal that the disconnect, strangely enough, was prominently evident during the demonitisation period (Nov ’16 onward), a time when sentiments were severely dented.

Domestic asset management companies probably never had it so good, with the inflow momentum only gaining in strength over the months. As per news reports, net mutual fund inflows in the fiscal year ended March ‘17 rose 155.66% from a year before to Rs3.43 trillion, the highest it witnessed in the last 11 years!!! This seems to be driven by strong inflows witnessed in SIPs and balanced funds. This is believed to insulate the markets from the velocity of the FPI flows.

That said, we must also be cognizant of the correlation of the Index returns with mutual fund flows. As observed in the adjoining chart, Index returns determine the direction of the flows (in the near term).

Market sentiment.png

If the surging inflows into mutual funds were not sufficient enough, the Labour minister recently announced the ministry’s decision to invest another Rs. 180 bn of EPFO corpus in stocks in the current financial year! News reports estimate another Rs. 20 bn annually invested into equities by the NPS. With the excess liquidity stretching valuations, how much more could the indices return in the near term and whether this flow sustains or not is anyone’s guess. Indians historically have had a low share of financials savings (as % to household savings) and that story continues irrespective of what the market has returned over the last decade or irrespective of the economic outlook going forward. What we can take some solace from is the fact that a large part (>50%) of the flows into domestic mutual funds are reportedly via SIPs. As these types of investments are believed to be sticky in nature, we can assume such flows could continue irrespective of the near-term market direction.

While the broader indices have moved up by ~16% in FY17, the BSE Small Cap Index and Mid Cap index outperformed the broader index by a wide margin. Consequently, the asset base of many funds, which invest/can invest in such stocks, has increased manifold over the last couple of years. And thereby the constant search for interesting companies which they can invest into. The coverage of mid and small-cap stocks in India is relatively poor. In addition, mid and small-cap stocks are largely under-owned by investors. Both parameters increase the scope for ‘mis-pricing’, which informed investors use as an opportunity to find, and invest in well-managed, thriving mid-cap companies whose prices may not yet reflect their value or potential. With thousands of companies vying for investor attention, whether this proves to be a challenge or offers an opportunity depends on how corporates articulate their communication strategies with relevant stakeholders. The significance of attracting such long-term investors as shareholders has only been underscored several times. The increasing flexibility of the domestic funds, to go down the market cap curve in search of investible ideas, throws the arena open to even smaller companies to communicate effectively and get into their consideration set, which hitherto was an uphill task. The portfolio manager is out there shopping. Are you on his list?? With the economy showing signs of recovery post demonitisation, companies yet have sufficient time to redraft internal strategies (if not yet done) and focus on this important management function to position themselves appropriately.

When your customer is getting bigger back home, why do you need to travel to Rome? 😊

Cheers!!!

Sudhir

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