Passive funds dominate India's FII flows

Accounted for 90% of inflows in March

An increasing number of foreign investors are coming through passive investment vehicles such as exchange-traded funds (ETFs). The proportion of such inflows in March touched nearly 90 per cent of the total, from an analysis of data from Kotak Securities.

Passive investment vehicles are considered less ‘sticky’ than actively managed capital. They allocate money to a portfolio which mimics an index such as the Sensex or the Nifty. This allows them to quickly move in (and out) of a market. Active fund managers, on the other hand, look to identify companies which can outperform the broader market or a benchmark index. They are generally seen to be more willing to commit capital for longer periods of time, with greater conviction.

India saw inflow of $532 million in March, of which ETFs accounted for $478 million, based on analysis of funds that Kotak tracks. Non-ETF fund flows were $54 million. The split had been 50:50 over the past three months, with India inflows through the non-ETF route $2.08 billion, while the ETF-route accounted for $2.2 billion. The past one year shows ETFs accounted for $5.7 billion, compared to $2.35 billion for non-ETF flows.



Passively managed funds have seen over $1 billion in inflows, even as other emerging markets (EMs) have seen stress since the year's start, according a Kotak Securities 'Foreign Fund Flow Tracker' report this week, authored by analyst Saifullah Rais. “Emerging market ETFs continue to see redemptions, with outflows worth $2 billion over the month. ETFs benchmarked to the MSCI India Index have attracted $1.5 billion over the past three months,” it said.

Meanwhile, funds which invest in Asian countries other than Japan have reduced allocations to India, although overall allocations remain high. “Allocations to India by Asia ex-Japan funds came off highs in February, falling from 13.9 per cent (to 13.7 per cent). China and India cumulatively constitute a third of the average Asia ex-Japan portfolio,” it said.

“This might be evidence of new investors coming into the market. Many new investors prefer to start with ETFs or index funds, as they might not have the required India expertise or long-term perspective for active fund management. It could also be individual investors who wish to be a part of the India story, since a number of such investors prefer to come through the passive route,” said U R Bhat, managing director at Dalton Capital Advisors (India).

Rajesh Cheruvu, chief investment officer at RBS Private Banking India, said there was limited risk of sustained outflows. “Flows might well depend on how the Fed (US Federal Reserve) behaves. It is expected that it might hike rates in the later part of the year but this is not likely to be a large one, perhaps around 25 basis points. There might be some immediate reaction in terms of sentiment about EMs because of the hikes but over the medium to longer term, these markets offer value, as developed markets are trading at expensive valuations,” he said.

Adding: “In India, recent steps by the government should help boost both investment and consumption growth. Earnings should begin to pick up in the second half. While there might be a knee-jerk negative impact of a Fed rate hike, a repeat of May-June 2013 seems unlikely.”

Earnings are expected to be better in the financial year’s second quarter than the first, according to Morgan Stanley’s India Equity Strategy report, authored by analysts Ridham Desai, Sheela Rathi and Utkarsh Khandelwal. Issued on the last day of the March quarter, it suggested the June quarter would also be a volatile one. For, it said, the current quarter was “likely to be news-heavy, with global developments around Fed policy, global growth data, domestic news flow around legislation and government policy, Reserve Bank policy and the coming earnings season (expectations appear muted).