Bank of America Merrill Lynch Research Report on India Equity Strategy

FII ownership at a new peak; GEM funds remain OW

FIIs continued to invest in India with December quarter witnessing FII flows of more than $2bn. This was the 9th consecutive quarter of positive inflows from the FIIs. Strong inflows from the FIIs over the last five years have resulted in all-time high foreign ownership for Indian markets (see Chart 1). As of Dec’14, FIIs collectively held ~23% of the market and ~47% of the free float. This compares to ~15% of total market cap and 36% of free float in Mar 2009. India OW is at an all-time high for GEM funds and the consensus bullishness creates the biggest risk to markets, in our view. The good news, however, is that domestic mutual funds have seen inflows and have been buyers post-elections after being net sellers past few years.

Index changes make financials all-time high OW for FIIs…

Financials continue to remain the highest overweight (OW) sector for the FIIs (at 14.3% OW). Continuous buying in the sector coupled with the exclusion of most private sector banks from MSCI India due to lack of FII room has made the OW at such a high level . During the quarter, financials once again the most bought sector largely led by SBI & HDFC. Private sector banks have mere $2.6bn headroom left for the FIIs (largely led by ICICI Bk & Kotak). However, PSU banks are not that well held and have headroom worth $5.6bn (led by SBI, BOI & Canara Bank).

…IT at an all-time high FII UW… Pharma also sees its UW rise IT on the other hand reached an all-time high underweight (UW) for the FIIs. All the three large software companies (Infosys, TCS and Wipro) are among the top- 10 UW stocks for the FIIs. Pharma has also witnessed its UW rise during the quarter. This is largely due to the combination of low flows in the sector (vs. its weight) and outperformance of the sectors over the past few quarters.

Domestic MFs: similarities and contrast with FII portfolio

1. The top four UW stocks for both FIIs and domestic MFs are the same – HDFC, Reliance, TCS and Infosys (though not in the same order).

2. Similar to FIIs, MFs are heavily UW software and energy. The UW on energy is largely driven by Reliance, similar to the FIIs.

3. Unlike FIIs, the biggest sector OW for domestic funds is industrials, where they have a massive 920 bps OW. Unlike FIIs, domestic MFs are UW financials (they are UW front line financials like HDFC Bank, HDFC and ICICI).

Domestic MFs flows becoming important for flows Flows from domestic MFs have been positive for the last nine consecutive months a first since last 15 years. Overall MF ownership is at a 12 quarter high though still lower than the previous peak. We believe MFs could become an important source of flows for Indian markets going ahead as retail participation rises.

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