Withdrawal of long-term foreign money a concern

US- and Europe-based long-term funds tracked by EPFR have withdrawn $4 billion, while short-term funds have infused $670 million since Jan 2012. 

Betting on a Bharatiya Janata Party government at the Centre after the general elections, foreign institutional investors (FIIs) have pumped in a huge amount of money into Indian markets through the past few months.

While the fact that Indian markets are scaling new highs brings relief to investors, there is a flip side to this, too.

Long-term funds have accelerated the pace of withdrawing money from Indian markets, while short-term money continues to pour in, increasing the vulnerability of markets.

“Our data suggests of the flows from US and European equity funds we tracked to India since 2012, both have seen longer-term, actively managed funds pulling out more money than ETFs (exchange-traded funds), which tend to be the vehicles favoured by shorter-term, ‘tactical’ investors,” said Cameron Brandt of EPFR, which tracks the flow of FII money.

Since January 2012, US- and European-denominated funds, typically considered long-term investors, have cumulatively withdrawn about $3.8 billion from Indian equity markets.

One of the reasons for the withdrawal is an economic revival in these countries; as these economies are likely to continue improving, the withdrawal might not ease any time soon. During this period, short-term money (typically, money coming from ETFs, etc) have deployed $666 million in Indian equity markets.

Since the beginning of September 2013, when markets had hit a low, long-term investors from these countries have withdrawn about $1.3 billion, while short-term investors have marginally increased their investments.

Experts believe a lot of the short-term money coming into India is aimed at availing of a pre-election rally.

Also, hope and consensus among market participants that India could have a stable government, which could announce reforms and revive the economy, has attracted foreign investors.

“There are expectations whoever wins will have made promises of significant economic reform, and some foreign money has moved in to take advantage of any reform rally. But how long that money stays will depend on the mandate the winner gets and the foreign perceptions of the winner’s ability to implement that mandate,” says Brandt.

Through the last few months, FIIs have built significant long positions in Indian markets, especially in large-caps.

They have deployed huge sums, more-than-offsetting the selling by domestic institutions. Since January 2012, FIIs have invested $49 billion, $4.5 billion this year alone. If it is short-term money, it could have negative implications on Indian markets, in case the election results aren’t favourable.

Even if election results are favourable, this money could see some liquidation, unless these investors see further gains in the market. Also, some selling pressure is expected, as investors or FIIs who have invested for the short term or during the early part of the current rally, take a part of the profits home.

The biggest concern is if the election results aren’t favourable, other participants will likely liquidate their long positions, and this could have a cascading impact on Indian markets. “If the election results are not favourable, we will probably have a downward knee-jerk reaction, but I think that will be a great opportunity to buy, as the economy’s fundamentals are improving and markets have already bottomed out,” says Siddarth Bhamre of Angel Broking.

“Each day, the market is seemingly pricing an NDA (National Democratic Alliance) victory; it is likely the markets will fully price this in by the time the elections are over.

Long-term money will only come once an improvement is seen in the fundamentals and return on equity,” said Manish Bhandari, managing partner and chief executive, Vallum Capital Advisors.

However, a few experts believe there might not be any major impact. “Certainly, there is substantial short-term money in the market, but we do not think that is a big concern because once the elections are over, some of the short-term money that will be withdrawn could be compensated by the long-term money waiting in the side-lines to be deployed, after clarity emerges,” said Deven Choksey, managing director, KR Choksey Securities.

How funds flow after the elections and what implications this has will need a close watch.

Except for liquidity, which could act in favour or against the market in the short term, most market participants are bullish in the long term, as they believe India’s economic fundamentals are improving and the flow of bad news has reduced.