Foreign institutional investors (FIIs) that have withdrawn nearly $40 billion from Indian equities in the last two years have little reason to invest in India, wrote analysts at Bernstein in a recent note. However, they may ‘return to trade’ in Indian equities rather than invest for the long-term, the note suggests.
“With large-caps struggling to reinvent themselves, incumbent business models facing disruption from new technologies and small-and mid-caps (SMIDs) difficult to access at institutional scale, the case for a structural India allocation has become harder to make,” wrote Bernstein analysts led by Venugopal Garre, the brokerage’s managing director, in a recent coauthored note with Nikhil Arela.
Over the next 12 months, FII flows, Bernstein believes, are likely to be flat to modestly positive even after two years of significant outflows. The view is based primarily on the easing of recent headwinds rather than any meaningful improvement in the structural factors that drive long-term foreign capital allocation.
“When the Nifty has delivered just around 6 per cent annualized USD returns over the past decade and nearly 11 per cent annualised declines over the last two years, the promise of India as a ‘bright spot’ matters far less,” Garre and Arela wrote.
Bygone economic era
India’s flows of domestic and foreign institutions, according to the Bernstein note have been showing cyclicality. The typical cycle was 2-3 years of foreign inflows followed by a year of lull activity when domestic institutional investor (DII) flows peaked and FIIs either booked profits or did not deploy cash.
For FIIs, the peak was around $25 billion a year, and for DIIs, it was lower around $15-20 billion a year. There have been a few instances (though relatively less) when both have been significant buyers – 2023 being the most recent one, Bernstein said.
Another issue Bernstein highlighted was the nature of India’s large-cap companies, which it believes represents a ‘bygone economic era’. Most companies, it said, are not investing in the future, but consolidating their past, often expecting policy to continue shielding them from global competition.
“One reason India has struggled to scale in emerging technologies such as electric vehicles (EVs), semiconductors and solar is the reluctance of companies with the deepest pockets to commit capital. If large-caps cannot provide the growth, FIIs must gravitate towards SMIDs. But separating quality from noise and identifying future giants requires specialist teams, dedicated resources and long investment horizons,” Bernstein said.
Most SMIDs, Garre and Arela believe, remain sub-scale, with low free floats, limited liquidity and sparse coverage, hardly an ideal destination for large institutional capital.
“Flows are often news-driven without strong anchors, and the same market that rewards a positive narrative punishes heavily when quarterly delivery disappoints. By the time the handful of winners become truly investible, much of the value creation is often behind them,” they said.
AI trade
Peaking of artificial intelligence (AI) trade across global markets, if any, going ahead also offers little hope of flows coming back to the Indian markets, Bernstein said.
Global capital, they said, was never designed to chase annuity-like returns while accepting the valuation, liquidity, and execution risks that increasingly characterize parts of the Indian market.
“Instead, a structural revival in foreign inflows will depend on India’s ability to build globally competitive industries in emerging areas: advanced semiconductor manufacturing rather than just assembly, deep capabilities in batteries and energy storage, greater energy self-sufficiency, and business models that can win meaningful market share globally,” Garre and Arela wrote.
