Over the last 3 months, we as a firm have been very active in communicating to our partners and investors around adding capital into the fund. This has really helped as we have had one of the best quarters of inflows during a difficult quarter that went by in terms of the market and for growth as a strategy (Mar – Jun 2022).
During our interactions with multiple partners and investors, some of who I regard as smarter than us, we have had one constant pushback and question – ‘Why should I add more capital into the markets, whereby the most sophisticated investors in the market – the FIIs – have been withdrawing money from the markets. The data shows that the previous 9 months of outflows were record numbers going back to 2008 and this is worrying’.
I find the above question an extremely rational one and while I will not have all the answers, the aim for this article is an honest attempt to explain why the thought process may not be the right way towards taking an investment decision.
I will break this article into three parts – two of which are backward-looking and one of which is forward-looking.
a) Narrative 1 : FIIs are the smartest and sophisticated investors It is important to understand that FIIs are also managing money for end investors. Which means, they need to be managing the same emotions as Investors who are Domestics. Their exposure in India has been at ~20% of the market cap of India over the last 15 years ( and has oscillated between 19.6% – 21.5% of the Indian public market cap over the last 15 years). I am not sure whether they are the smartest but its important to put this in context.
b) Narrative 2 : FIIs have redeemed record numbers and this goes back to 2008. Are we going into one such bear market. It is always important to put numbers into context. While the absolute redemption of the FIIs between October and June (2022) was cumulatively higher than in 2008, in relative terms it amounts to ~1.6% of the India market cap today. Effectively they were rebalancing their portfolio to the mean of the last 15 years. I personally would not read much into this, but the numbers will sound big, because the India market cap has gone up 4x in the last 13 years.
c) Narrative 3 : I will invest once the FII redemptions slow down and they begin to invest This again is a flawed way to look at investing decisions as an investor is basing his/her decisions on some group they have no control over. More importantly, when FIIs come back into the market, their buying will predominantly be in financials where they have been underweight on. But since this requires some amount of forward estimates, I will look at spending most time here and explain how we view things on the ground.
Over the last 20 years, FIIs globally allocate money to Asia-based funds (which command a lion’s share of fund management AUM today – ~85%). Country-specific funds will always have a much smaller share of the AUM as they bring an excessive amount of risk from a geographical perspective to a global investor (ex-US).
Over the last 8 months, there has been an interesting theme emanating among FIIs which I believe will begin to gather steam over the next few years. Today, there is an emergence of a new asset class / theme called EM ex-China (Source : https://www.investmentweek.co.uk/opinion/4053583/emerging-markets-china-future)
Why is this happening and why is this important? For the last 20 years, China has been the biggest source of capital for Global FIIs – due to the population, GDP expansion, growth on the ground and the potential future returns that one can generate. However, the last 3 years around Covid, anti-capitalistic measures and risks to capital allocation on the ground due to policy has made FIIs think about allocating capital to EM ex-China. Now, why is this important?
Today, in an EM index, China has a 34% market cap exposure and India has a 12% market cap exposure – which means for every $100 allocated to EM, India gets $12. In the EM index ex-China, India’s allocation goes to 20% in the index. This has significant impact for marginal flows that get allocated to India going forward. The below graph explains the same from an allocation perspective and the impact.
Source : GS Research, Factset, MSCI Data
While a lot of this was only a narrative and a discussion thus far, one of the largest EM managers globally, has now started an Emerging Markets Ex-China growth fund that they are marketing (Source : https://www.businesswire.com/news/home/20220728005779/en/William-Blair-Investment-Management-Introduces-Emerging-Markets-ex-China-Growth-Fund)
We as a firm believe that predicating investment decisions on FII inflows are not very wise, but even if one was to do this, we expect things to materially change over the course of the next few years. This piece was not written with an intention to call for a market bottom or with an aspect of being a soothsayer but to look at why predicating investment decisions based on FII flows may not be the sensible thing to do.
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