For a long time, Foreign Institutional Investors (FIIs) ruled Dalal Street. Their mood decided which way the Nifty and the Sensex swung, and they were the main players in the market.

That has changed recently - FIIs equity AUM in India is around $586 billion, while DIIs are roughly around $580 billion. The gap between FIIs and domestic investors has narrowed by around $140 billion in just two years.

The rise of mutual funds, pension funds, insurance schemes and discount brokers has helped increase domestic and retail investments into equities. The Indian population’s equity exposure has more than doubled from 1.3% in 2011 to 3% in 2023. While this penetration rate is still peanuts compared to the US market's 55%, the jump has been enough to skew the markets towards domestic investors.

The surge in domestic institutional investor (DII) money has taken a bite out of FII dominance – domestic inflows  have outpaced FIIs in the past 18 months. DIIs have invested $39 billion in the equity market, while FIIs have withdrawn $24 billion. DIIs have been the wall against potential declines for the Nifty 50 .

What is driving FII money out? Higher bond yields in the US, cheaper equity valuations, and a stronger dollar have been major reasons.

In this week’s Analyticks:

• FII sour on India, for now: Should retail investors worry about FII outflows? 
• Screener: Stocks with rising FII holdings and strong Q2FY24 performance 

Let’s get into it.

Smallcaps jump, FIIs withdraw from large caps 

Since the beginning of 2023, FIIs have withdrawn nearly Rs 52,188 crore from the Indian equity market. In the same period, DIIs invested around Rs 1,55,861 crore.

DIIs sustain Indian markets amid FII outflow over the past 18 months 

DII money has compensated for FII outflows, but the investment preferences of these two sets of investors are very different.

The Nifty 50 has risen by 6.8% since the start of 2023. In contrast, the Nifty Midcap 100 and Nifty Smallcap 100 have jumped 30.1% and 39.9%, respectively. The growth in smallcap and midcap stocks is disproportionately high, thanks to DII interest in these stocks. FII investments have been mainly in large, and some mid-cap companies.

In largecaps, the damage from FII outflows has been cushioned a bit by DII inflows. But in smallcap stocks, the sheer volume of DII investments has resulted in remarkable returns. The low market cap of the Smallcap index also means that it benefits from even modest DII inflows.

For example, an inflow of Rs 100 crore into a company with a market cap of Rs 1,00,000 crore is unlikely to move its stock price much. But the same amount can do wonders for a stock with a Rs 10,000 crore market cap.

Higher US interest rates pull FII money from India

With US treasury yields near a 16-year high of 5%, FIIs are pulling money out of Indian stock markets. Since April 2022, when US interest rates began to rise, FIIs have taken out nearly Rs 2,00,269 crore. Rising US interest rates make it expensive to borrow money for Indian investments.

Historically, Indian indices fall with a rise in US treasury bond yields, due to FII outflows. However, the recent DII inflows have cushioned the impact this time. DIIs have invested Rs 3,27,858 crore from April 2022 to October 2023.

DII investments buffer the impact of FII selling 

The dollar also recently breached its previous high of Rs 83 against the rupee. A stronger dollar makes investments in Indian equities more expensive, as a depreciating rupee reduces gains. The dollar-adjusted returns of the Nifty 50 stand at 6.1% for 2023. The relatively cheaper valuation of US equities compared to their Indian counterparts also makes the US market more attractive for FIIs.  

With lower PEs, stocks in the US are cheaper than in India

For instance, Nifty IT is expensive at 26 PE, higher than Nasdaq 100’s 23.2. US stocks also have the advantage of a global presence, while Indian stocks are limited to domestic markets (except for IT)

Despite outflows, India remains a top choice for fund managers

The IMF projects India’s GDP growth at 6.3% for 2023 and 2024, the highest among emerging markets. Even China is expected to trail behind India, with a growth of 5% and 4.2% in 2023 and 2024. India’s inflation, currently at 4.5%, is expected to decline further thanks to falling vegetable and crude oil prices. 

This is particularly significant as many countries are struggling with price increases, economic slowdowns, and political tensions. In contrast, India’s huge domestic consumer market has helped the global recovery, making it a significant player. These factors make India an attractive option for foreign fund managers.

India tops as the leading FPI destination in 2023

Unlike FIIs, selling from foreign portfolio managers has been limited as they largely invest in indexes (like ETFs) rather than single stocks, and are governed by weightages.

Foreign portfolio managers invested nearly $12.2 billion into India from January 2023 to October 2023. In contrast, China fell out of favor with recent US sanctions and complex rules around foreign investments, and saw FPI outflows of $7.8 billion. 

Capital goods sector leads in FPI inflow since January 2023 

India's capital goods sector, especially the FMCG segment, has seen the highest FPI inflows. Increased market penetration in rural areas and the premiumization of products have made capital goods a favoured sector for FPIs. However, India’s extensive imports of Russian oil, which risk attracting US sanctions, have made some FPIs take out money from the oil&gas sector. 

While foreign portfolio managers show confidence in the Indian market, FIIs have been more fickle. DIIs have been sticking around, actively investing without any signs of slowing down.

Once the US Fed starts to reduce interest rates, as expected in the second half of 2024, the Indian equity market will likely see an influx of FII funds again, pushing the market to new heights. Until then, it seems that DIIs will run the show.

Screener: Stocks with increased FII holding, strong performance in Q2FY24 and outperforming the Nifty 50

Five-Star Business Finance has the highest FII change

As the shareholding data for Q2FY24 rolls out, we take a look at stocks with the highest rise in foreign institutional investor (FII) holdings. This screener consists of stocks that have seen a rise in FII holdings over the past quarter with strong financial performance in Q4FY23, outperforming both their industries and the Nifty 50 index.

The stocks in the screener are from industries like banks, IT consulting & software, auto parts & equipment, pharmaceuticals and non-banking finance companies (NBFCs). Major stocks in the screener are Five-Star Business Finance, Medplus Health Services, Adani Power, Blue Star, CreditAccess Grameen and CE Info Systems. 

Five-Star Business Finance tops the list with the highest rise in FII holding. It increased by 41.5 percentage points QoQ to reach 50.2% in Q4FY23. Funds like Tpg Asia Vii Sf Pte, Sirius Ii Pte and Norwest Venture Partners X - Mauritius have bought 14.3%, 6% and 5.3% stakes, respectively, in the NBFC. The company’s stock price has risen by 6.6% over the past month, boosted by strong Q2FY24 results.

Medplus Health Services has also seen its FII holding rise by 7.5 percentage points QoQ to 12.4% during the quarter. While major buyers of the healthcare supplies stock were the Steadview Capital Mauritius and the Government of Singapore, which bought 1.7% and 1.5% stakes, respectively, Fidelity Funds - India Focus Fund increased its stake by 1.4%. The stock has risen by 6.6% over the past month, owing to strong Q2FY24 results.

You can find more screeners here.