Indian equities dictated by passive flows: Kotak Institutional Equities

The Indian equity market is being dominated by passive flows — overseas money coming in through exchange-traded funds (ETFs) and domestic flows through monthly systematic investment plans (SIPs).

The growing role of non-institutional investors has resulted in weakening linkage to fundamentals and growing confidence in ‘riskless’ returns — an ideal situation for low volatility at most times, but with large potential risks in the case of any untoward event, a report by Kotak Institutional Equities said.

Mutual funds have seen inflows of nearly ₹2-lakh crore in the last one year. Foreign investors have put in $13.4 billion through ETFs in the 12 months to March into India compared with $4.7 billion through the non-ETF mode.

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FPIs turn net sellers

Foreign portfolio investors (FPIs) have turned net sellers in the past few weeks due to the unfavourable risk-reward balance and better returns elsewhere, especially China. FPIs have been less active in India for a while due to low inflows into emerging market funds, high share of passive flows, full-to-rich valuations across sectors and low interest in outperforming ‘narrative’ stocks. India’s weight has increased steadily in the MSCI EM Index, but active global emerging market funds have stayed underweight.

“Our analysis of the BSE-200 stocks shows that FPIs continue to prefer large-cap private banks, consumers and IT services stocks. These sectors have been laggards over the past three-four years, with many of the large-cap stocks being massive under-performers. Their apathy toward PSU stocks, based on past experience and adherence to ESG principles, may have precluded them from participating in many high-return stocks,” the report observed.

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Wrong valuation

Domestic institutional investors, on the other hand, are positive equities. That’s because the bulk of inflows into mutual funds and life insurance companies is from retail investors, with hardly any institutional money, with the former deciding the quantity, timing and type of investment.

The brokerage said the market is baking in optimistic profitability and volume assumptions, using wrong valuation methodologies and fabricating implausible narratives to justify the current market capitalisation of stocks.

“We struggle to find value in the market with most sectors and stocks trading at full-to-rich valuations, with no link to fundamentals. The narratives and fanciful valuations surrounding many stocks in the automobile, capital goods and PSU sectors will not stand even a modicum of scrutiny,” it said. “We can only hope that there is no untoward incident to jolt the market out of its ‘riskless’ mode.”