Emerging Portfolio Fund Research (EPFR) Global is a US-based firm that tracks fund flows and manages $10 trillion in assets across countries and instruments. Brad Durham, managing director, EPFR, tells Jitendra Gupta that foreign institutional investors (FIIs) are not overweight on India and FII inflows are likely to fall this year.
Is dollar carry trade active across emerging markets? Does it pose any risk to these markets?
Though there is risk that money coming through dollar carry trade in emerging markets can be withdrawn when interest rates rise in the US and the dollar strengthens, I think the threat has been overblown. The record flows into emerging markets have been driven by economic fundamentals. Also, both public and private pension funds in developed markets have decided to increase their exposure to emerging markets.
Given that stock markets have almost doubled in the last one year, how are FIIs viewing India now?
Last year, India was among the four best performing markets in the world. The year ended with its third-best performance in a calendar year. While some investors will be attracted due to this, more prudent investors will be wary of such a market.
Investors will keep a close eye on valuations and earnings of companies to confirm if this heady performance has made markets unreasonably expensive. Trading on a 12-month forward price-to-earnings multiple of about 17 times, India is considerably more expensive than the emerging markets average of about 13 times.
But India’s valuation, relative to the MSCI EM index, has declined since the beginning of last year, and at this point, I don’t think foreign investors are viewing Indian equities as overvalued.
Do you see any reduction in the weight FIIs have given to Indian equity markets?
Indian companies are valued at about 20 times 2009 earnings and at forward multiples of around 17 times. Compared with emerging markets or India’s historical valuations, this is not cheap. One of the reasons for such high valuations is the strong performance of equity markets in 2009, which has helped improve India’s weight in emerging market equity funds tracked by us. As of December, the average India weight in the Global Emerging Market equity funds that we track was 7.7 per cent.
While this is slightly down from the all-time high of 8 per cent in mid-2009, it is clear that fund managers have been selling in a rising market and are unwilling to increase their holding by more than the 7-8 per cent comfort zone. Given this background, it does not seem that India is in overbought in these portfolios and thus not vulnerable to a sell-off. But Asian regional equity fund managers have allowed their India weight to rise to an all-time high of 7.9 per cent. So, there may be some vulnerability there.
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What are the major worries that FIIs have with regards to India?
A major worry is corporate earnings not meeting forecasts. Also, a disappointing monsoon resulting in higher prices of food, and oil, considering that India is a net oil importer. Investors are generally impressed by India’s 7 per cent-plus gross domestic product growth and the recent recovery in the industrial sector, but worry that it has not been matched by growth in credit and that economic recovery and inflation may cause the central bank to tighten monetary policy. When central banks adjust their positions, there is always a risk of policy mistakes.
How are FIIs looking at the currency risk, especially in emerging markets?
With expectations that the dollar was oversold last year and a recovery is due, investors will be more careful about their exposure to other currencies this year. The emerging markets currencies, which performed best against the dollar, are the most vulnerable. Since the rupee appreciated only modestly, I don’t think rupee-denominated assets are that vulnerable.
Globally, are investors still buying equity and moving away from debt?
For the most of 2009, investors moved record money into bond fund groups. A number of US bond fund groups, US and Europe high-yield bond funds, and emerging market bond funds recorded all-time high inflows. While money also came to emerging markets, bond funds benefited the most.
With higher interest rates and inflation expected in 2010, and the economic recovery in full swing, I think investors will have preference for equity funds over bond funds in 2010.
In 2010, will FII inflows increase or decrease as compared to last year?
I am fairly confident that FII inflow this year will be lower. And that is partly because of the strength of last year’s flows. We track equity funds, which have about $76 billion invested in Indian equities, and these funds made net investments of about $7 billion last year. I don’t think investors will exceed that amount this year since the equity market’s performance is expected to be tepid. Also, central banks will withdraw some of the massive amounts of liquidity from global markets this year.
