Foreign investors rush in as mutual funds fear to tread

Meanwhile, equity MFs had increased their aggregate cash level to multi-year highs at about 5%

Mutual funds shed equities after six long months, even as foreigners continued loading up on shares, their investments climbing to a six-month high in February. Even as mutual funds dumped stocks worth Rs 78 crore in February, foreigners shopped equities worth Rs 10,000 crore, pumping up indices four per cent this month, and 12 per cent from demonetisation lows in December. 

In this equity about-face, mutual funds (MFs) cling to caution in the face of lofty valuations, even as foreigners raise their game amid weak price of dollar (relative to other currencies). 

Ever since October 2016, MFs have invested Rs 43,875 crore, at a monthly average of Rs 7,312 crore. During the same period, foreign institutional investors or FIIs have pulled out Rs 12,150 crore (monthly average Rs 2,024 crore). 

After a sharp 12 per cent rally since December 26, the benchmark Sensex now trades at 19 times its components' one-year forward net profits. Analysts say valuations loom near correction territory. 

"These are precarious levels -- not in the interest of investors, given the poor net profit growth," said a chief investment officer, managing a little over Rs 20,000 crore of equity assets. 

"It's all liquidity which is taking the markets higher. There are near-term uncertainties like state election results and revival of corporate profits. We are taking a defensive stance, and for investors, it would not be a bad idea to book partial profits," he added.

The sharp FII inflows come after heavy sell-off in November and December 2016. Foreign outflows were seen stemming in January as a stronger rupee price spurred risk appetite. India-focused funds have been getting positive flows since January. Market players say FII inflows are subdued as a large portion of the buying in February was in HDFC Bank, after the Reserve Bank of India lifted investment ban on the stock.

Meanwhile, equity MFs had increased their cash holdings to multi-year high at five per cent of total equity assets.

"There has been quite a lot of volatility in stock markets. Generally at such times, fund managers tend to be more cautious, which is right to an extent," said Kaustubh Belapurkar, director, fund research, Morningstar India. 

Investor flows into MFs continue to remain strong. Between April 2016 and January 2017, equity MFs got net inflow of more than Rs 50,000 crore.

Gautam Chhaochharia, head of India research, UBS Securities, says MF inflows have tracked market returns.

"Investors should not look at a decrease in local inflows as a lead indicator for Indian markets - flows will follow returns rather than the other way round. This means the recent market strength may continue despite expected sharp profit declines ahead. Our end-2017 Nifty target remains 8,800, though inflows could drive markets up further in near term to 9,700 as long as there are no global shocks, declines in global risk appetite, and immediate local negative catalysts (such as Uttar Pradesh election results or January-March profit disappointment)," he said.