For a very long time, especially since the reforms of 1991, Indian equity markets have been fundamentally dependent on overseas sources of liquidity (FPI/FII flows). That has changed in the last couple of years and has been perhaps the biggest structural change in the same period for our markets.
Domestic liquidity has become predominant, and it acts as ballast to the Indian equity market. The well-known, and the largest, source of domestic liquidity has been mutual funds.
Data reveals that in the last four years MFs have come to overwhelm FIIs investments by almost 2-4 times over, mainly powered by SIP investments that now comprise 50-70% of the MF flows. Further, the turnover of mutual funds is far higher than other categories of domestic and international investors, resulting in a strong correlation of Nifty 50 with MF investments (+70%), while that with FIIs investments is considerably weak (+11%).
FIIs that kept up the market momentum during FY10 to FY14 lost the correlation thereafter. The decline and even outflow from FIIs have not been a market moving event thereafter.
However, the relatively unknown part of the liquidity ballast is the infusion by other domestic institutional investors’ segments namely the insurance companies, PFs/NPS/EPFO and the retail segment. While MFs are significant, as per our estimates, they comprise only half of the flows to the Indian institutional equity market. Insurance companies regulated by IRDA contribute another one-fourth of the total DII flows in the equity market.
The remaining one-fourth is contributed nearly equally by the provident funds & NPS. All these categories of DIIs have seen a significant jump in their total investment in equity consistently over the last four years.
It is estimated that the annual flows by all DIIs would aggregate to around ₹2.5 trillion, i.e., almost double the net investments by MFs. Taking all the DIIs together would reduce FIIs’ share to a mere 10% of the institutional segment, explaining the dwindling influence of the latter in the Indian equity market. In terms of turnover, mutual funds see a higher churning compared to other segments of DIIs. Thus it is seen that while in net investment terms MFs comprise only half of all DIIs, in terms of net turnover, MFs net investment may equal or even exceed the net turnover of all DIIs.
The high, stable and growing flows from DIIs have various implications for the Indian equity market.
First, they add to the market resilience as close to 85% of the DII flows, including the SIPs and the institutional flows other than MFs, are structural in nature. This has ensured that any selloff by other market constituents (viz., FIIs) are effectively set off, thereby warding off any ensuing volatility. It’s no wonder that the correlation between net DII turnover and net FII flows are not only negative but very high on absolute value at -82%.
Second, as the DIIs are institutions are mandated to invest in the equity market, a little tweak in the investment norms to invest higher would result in sizable incremental flow to the market. As these institutions operate below the ceiling prescribed for equity exposure, even a simple administrative order of raising equity investment by 1% of AUM can result in an additional flow of ₹500 billion, i.e., around 20% of the current flows of all DIIs, including MFs.
Similarly, a behavioural change of household savings’ flow to the equity market by 1% of gross financial savings can result in another ₹150 billion flowing in to the equity market. Finally, it has been noted that the size of DII flows is sizable and would comprise around 1-2% of the total market-cap of all listed companies. However, if we restrict it to the relevant universe of BSE 100, more in alignment with the conservative investing norm of these institutions, the DII flows would comprise around 5% of the free float market cap of the BSE100 companies.
If we consider the possibility that these funds wouldn’t be deployed evenly across time period but may happen periodically and at times be lumpy in nature, we would be left with significant “day of the event” impact.
Thus non-MF institutional flows could be the ‘invisible hand’ that not only acts as an automatic stabiliser but also prep up the market valuation on a structural basis. What it ensures is to keep the market afloat for an extended window for the fundamentals to catch up.
“We remain of the view that India is in the midst of domestic liquidity supercycle,” Morgan Stanley India strategists Ridham Desai and Sheela Rathi said in a research note.
