The media would have us believe that something incredible lies in FII money making a comeback to Bombay. The fact remains cash burns in CASA accounts with Banks and Money Market Funds earning nothing. It is just as well this money comes into Equities where large cap names will offer much significantly superior returns over a period of two years, than sticking to the policy of capital preservation and holding cash.
 
In a dramatic about-turn in their stance, FIIs have pumped over Rs 10,000 crore (on a net basis) into Indian stocks since mid-March, fuelling a 45 per cent surge in the Sensex, while for nearly a year till then, they were on the sell side.

What has taken the recent rally far beyond the expectations of most domestic investors is the quantum of inflows, with recent FII buying transforming net outflows of Rs 6,151 crore for the first three months of 2009, into a net inflow of Rs 3,970 crore year-to-date for 2009.

FIIs have almost single-handedly kept the market rally going from its March low, with both domestic institutions (DIIs) and retail investors taking opportunities to cash out. So what has caused the about-turn in the FII mood? The reasons range from India receiving its automatic share of higher emerging market allocations, to foreign investors finally taking note of the superior growth prospects of India and China.

'Automatic' allocations

"Investors who had refrained from taking exposure to emerging markets are now re-allocating funds, especially to BRIC countries," says Mr. Andrew Holland, CEO-Equities, Ambit Capital. While the initial surge in Indian equities was in keeping with this trend, the incremental gains may have been due to "inflows from global investors who were otherwise sitting on cash" he adds.

According to global fund tracker EPFR, this pattern of cash coming off the sidelines and bypassing developed markets in favour of emerging market equities had started in late March and has lasted into May.

"It was always expected that once the global markets turn, India too would benefit given its growth visibility and relatively better fundamentals," says Mr Prashant Sharma, Head of Investments, Max New York Life Insurance Company.

Rare growth story?

Apart from being beneficiaries of a larger emerging markets pie, China and India have also been singled out for their improving macro indicators, feel some fund managers. Mr. Sankaran Naren, CIO-Equities, ICICI Prudential AMC states that "while the macro indicators of most countries have witnessed less contraction, India and China on the other hand are beginning to reflect growth".

However, Mr. Kenneth Andrade, CIO, IDFC Mutual Fund cautions that recent inflows are just a 'replenishment' after the massive pullouts (Rs 53,000 crore) of last year. "Since India was among the markets that saw the largest pullouts by FIIs in 2008, a part of the current inflows should be seen as only replenishment for the market and a rebalancing act by those who went underweight on India."

While the flood of FII money has been swiftly lifting the markets, domestic institutions have been quietly offloading stocks over the past month. Attributing this selling to profit booking rather than a change in outlook, Mr. Milind Pradhan, Head of Equities Trading, Standard Chartered Capital Markets says, "both the insurance and mutual fund houses had bought fervently throughout last year and were the only ones who were buying when the market was at 8000. So, after this phenomenal rally of 30-40 per cent in the last couple of months, it is but natural to book profits." Besides, with little liquidity or opportunity to rejig their holdings in 2008, funds could have utilised the current markets to reshuffle their portfolios, suggests Mr Andrade.