FPI ownership of Indian equities drops to a decadal low of 16.6% in 2023, selloff triggered by portfolio underperformance & spike in US bond yields

• Sell-off by FPIs has been triggered by the underperformance of preferred stocks and outperformance in their least preferred sectors.
• Drop in FPI ownership comes as a surprise to analysts considering fundamentals of the Indian economy have never been better.
• Despite the selloff since September, calendar 2023 sees net inflows of $12 billion n by foreign portfolio investors.
  

As legendary investor Benjamin Graham often said, Mr Market constantly buys or sells a stock based on emotion and not on sound investing principles. Not surprising it is hard to make sense of the market and its gyrations. Even as India’s macro fundamentals are growing stronger each passing year, holdings of foreign portfolio investors have plumbed to their lowest level in a decade at 16.6%. What has contributed to the sell-off by FPIs is the underperformance of their preferred stocks and outperformance of stocks which they least preferred. In calendar 2023, small and midcap stocks have rallied by over 40% but the large caps have not done much. This is also a big reason for the selloff by FPIs.

As US Treasury yields breached 4% levels, foreign investors began selling down India yet again from September 2023. This has resulted in their equity holdings reaching their lowest level in a decade. According to ICICI Securities, a leading domestic financial institution, this is a surprise, considering the favorable fundamentals of the Indian economy.

The recent sell-off by FPIs has been driven by the decisive breakout of US bond yields above 3.5-4% post-September 2023. This spooked capital markets, despite the US Federal Reserve approaching the end of its rate hike cycle due to a moderating inflation outlook. The portfolio orientation of FPIs has also contributed to the drop in their equity holdings, with underperformance in their overweight position in high-quality, relatively expensive financial stocks and outperformance in their underweight position in industrials.

Says ICICI Securities, “Data on aggregate sectoral institutional flows available during October 2023 indicates FPIs bought more of industrials while large selling was observed in financials. Also, quarterly corporate filing data on shareholding pattern indicates an uptick in small and midcap holdings and a dip in large cap holdings.”

However, it is important to note that despite the recent sell-off, the overall FPI inflow for the year 2023 remains robust at $12 billion. This indicates that foreign investors still have confidence in the Indian market. India stands out compared to all other emerging markets, where FPIs have remained net sellers or have bought only marginally.

Additionally, domestic institutional investors (DIIs) have been actively investing in Indian equities, with overall domestic institutional flows reaching $20 billion in 2023 so far. Mutual funds have been particularly active, with net inflows of $17 billion.

The aggregate holdings of FPIs currently stand at ₹54.5 trillion, representing 16.6% of the overall Indian equities as of November 2023. This is the lowest level since 2012. The drop in FPI holdings can be attributed to the sharp selling seen since September 2023, as well as the underperformance of their portfolio orientation.

Recent activity by FPIs suggests a recalibration of their portfolio orientation. Data on aggregate sectoral institutional flows in October 2023 indicates that FPIs have been buying more industrials while selling off financial stocks. Additionally, quarterly corporate filing data on shareholding patterns shows an increase in small and midcap holdings and a decrease in large-cap holdings.

On the other hand, domestic mutual funds continue to show buying interest across sectors, particularly in healthcare, private banks, other financial services, and industrials. However, selling was observed in PSU banks during October 2023. This indicates that domestic investors have a more optimistic outlook on certain sectors of the Indian market.

Despite the volatility in the market, systematic investment plan (SIP) inflows have been steadily rising and have reached over $2 billion per month. This structural increase in SIP inflows demonstrates the long-term confidence of retail investors in the Indian equities market.

In conclusion, the recent drop in FPI equity holdings in Indian stocks to a decade low is ironic considering the favorable fundamentals of the Indian economy. However, the robust overall FPI inflow for 2023 and the potential for a reversal in FPI holdings as yield spike fears recede and valuations become more reasonable provide hope for the Indian equities market. It is important to monitor the election-related uncertainty, which could add volatility to near-term flows.