Passive Foreign Flows Into India Via EM Indices To Rise, Says Macquarie's Aditya Suresh
India's weightage in the MSCI standard index will increase 40 basis points to 19.8%.
Passive fund flows from overseas investors into emerging market indices, excluding China, will grow and Indian equities will benefit, even though the country will see less allocations on a standalone case, according to Aditya Suresh, managing director of Macquarie Capital.
Indian equities have seen Rs 18,162 crore worth of inflows so far in 2024, according to data from the National Securities Depository Ltd.
"EM, ex-China, as a category will see more inflows and within that, India will stand out as a benefactor. But I don't think India on its own will see foreign allocations expanding," the head of India research told NDTV Profit's Niraj Shah.
India's two-year forward return on equity is over 16%, while that of emerging markets is under 14%. He highlighted the "quality compounding characteristic" of the domestic market that will make it resilient even in the face of a global correction.
India's weightage in the MSCI standard index will increase 40 basis points to 19.8%. The upgrade will see index market cap for India increase by $57.26 billion, MSCI had said on Tuesday.
Neighbouring China saw its weight in the index drop 50 basis points to 24.2%, with the nation's index market cap declining by $4.57 billion. The MSCI India Domestic Index saw eight additions and no deletions in the August review.
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Here The Are Edited Excerpts
Since Covid lows, the principal mover of risk assets has been the Fed. We are very close, or we are closer than what we were 10 days back to the September meet, where presumably there will be some bit of rate action from the Fed. At least the markets who want to believe that right now. Should the markets be nervous in anticipation or do you expect a risk on of sorts, in risk assets because of that?
Aditya Suresh: From an India perspective, Niraj, if I just frame this a little bit, the broader dynamic is that domestic flows and what's really impacted domestic flow has been far bigger of a support factor here for our market. So as a case in point, for example, when you look at the cumulative data, fiscal '22 to fiscal '25 so far, foreign flows have been about, say, $5 billion cumulative. We saw almost that scale of flows this last month from domestic mutual funds.
So I think what's really going to happen domestically was far more of an explanatory factor here for our market. It is, at least our base case expectation that the RBI probably holds ground in the next two quarters, we'll see kind of how they respond to any potential Fed actions, but at least for now, our base case, the RBI, holds ground. So I'm looking at the domestic flow dynamic far stronger or far closer than necessarily the Fed actions here.
But do you reckon that a Fed rate cut, if it were to happen in September, might just spur sentiment globally for equities by and large and could that be constructive because, I mean, I was just looking at charts since 2020 and there has been, if not a near mirror image, then, or not a near perfect correlation, then a fairly strong degree of correlation between the Fed action and global markets’ movements. Of course, different markets would react to it in different percentages, but the direction broadly has been similar?
Aditya Suresh: I think that's probably a pattern to kind of play out as well right now. I think there's an element of, why is the Fed cutting? Why would the Fed cut and is that more a sign of caution, or we will see now. I think in general, could they be like some sort of positive sentiment that, to the extent that the Fed might cut, we buy that.
Okay, let's talk about flows. Aditya, since you spoke about domestic flows, but I'm more inclined to understand from you, because you guys have such great experience with regards to what global clients might be thinking like. What is your messaging to clients when you talk to them about the India story currently, and what is their feedback, particularly because we haven't, or we are definitely not, the recipient of flows, Is it an EM thing? Is it an India-specific thing? If it is an India specific thing, why do you think this is happening?
Aditya Suresh: I think that's a good starting point, which is that it's not necessarily the case that India has been a benefactor of China's diversification flows. As you point out, for example, when you go back and look at the data in that sharp selloff period for China between ‘21 and ‘22 overall, MSCI, emerging markets, ex-China, saw outflows. After that India also saw outflows on an absolute basis.
In 2023, that category saw inflows and within that India captured a stronger share of those inflows. So that was supported, but so far this year, as you pointed out, flows have been inconsistent, and it has been about neutral. So, in terms of the broader kind of foreign funds, the key summary block remains clearly valuations and headline valuations.
Our submission on this topic is that the headline is likely to remain, at least on relative terms, elevated, and the reason why it remains elevated is more about what's happening locally in terms of domestic liquidity. So the conclusion of one of our recent reports kind of released was that the question was, I mean, how long these valuation premiums kind of last?
But the real substance and the crux of the note was that we think that India remains a rich bazaar and these deep valuation premiums could exist and these dislocations could exist because there is so much domestic liquidity kind of chasing up these assets. But it is a tough one, foreigners. There is clearly a dynamic here where headline valuations was a stumbling block, say, even 12 months back, it's become even bigger of a stumbling block today.
In the past, the most common argument was at some point of time when the markets reached these stratospheric valuations and so on and so forth and if there was bad news, the markets would correct. quite significantly. Is the template of the market because of the local liquidity slightly different this time in the way bottoms are formed very quickly, or markets don't correct at all?
Typically, if markets used to correct because of factors at some point of time, global flows would come in when the valuations would become cheaper, and that would be the bouncing board for the market this time around. Could it happen that global investors may not get the markets too cheap in India, because the local flows are consistent month on month, and they are not ebbing?
Aditya Suresh: I think the way you describe it is largely kind of our view. But just to articulate some of the risk factors. What are we facing here at these high valuations? So, across measures, whether it be India versus itself, or India versus emerging markets. Take a pick on how you measure this, we will be about two to three standard deviations above normal. There is no kind of escaping a factor.
Now we don’t sit here and say that’s going to mean revert and we don’t think it means revert because of domestic liquidity dynamics which you spoke about. But just before I get into the domestic liquidity piece, which I strongly buy into. Some of the key points, as risks which we think about which we still need to work through. Why a potential kind of pullback can’t be ruled out clearly is that... there is clearly fatigue across sectors and consensus. I think we are overstretched. Point one.
Our growth premium compared to emerging markets that meaningfully compressed... I think it is interesting to observe that insiders have been cashing in whether it be MNC’s P/E investors and so on and so forth and only about say 5-10% of this cashing in is being for growth capex.
So, all those kinds of points of concern here for us. Typically, what we have said, then, in the face of the high valuations and these concerns that we should be as a market trading far below where we are, where we are today. These are catalysts with enough kind of cause, that kind of compression. But even in the past few days, what we've seen is that this entire domestic liquidity theme is, I think, well appreciated. The sheer scale and magnitude have clearly been surprising on the upside, and just kind of reiterates the same points, like what we saw last month in just for perspective is worth what we saw as foreign flows on a cumulative basis for three years, one month.
Sorry Aditya, care to repeat that, please and the significance of this?
Aditya Suresh: So what I was trying to get at is this last month, the July data, in terms of what AMFI publishes, what we saw as net inflows to equity markets in one month was worth almost what we saw as cumulative flows over a three-year period from foreigners. That, I think is kind of the real kind of case in point here, where the pace, these flows, stickiness, the magnitude, also is surprising us on the upside.
That's the important one of the equation. So, one is you see that they have financialization of savings dynamic, and that's more from the retail participants, whether that be through direct or indirect kind of allocations. But then also, you saw in the past couple days how LIC is speaking about them, a fund allocations. But then also you saw in the past close to about $20 billion to equity markets this year, that's incremental flows.
Then you look at the EPFO data, the EPFO mandate allows for 15% to be allocated to markets we're sitting under that limit. So in addition to the kind of retail participation, whether it be direct or through mutual funds, then the LIC piece, then the EPFO piece. A lot of this flow is not really reactive or responding to headline P/E multiples or more allocation choices. So that theme in itself, I think, has legs to go. So therefore, in our recent piece, what we basically concluded was that while there are reasons to be cautious, and there are several reasons to be cautious, even where headline valuations are at, and therefore a drawdown is likely, our views are, these drawdowns would be bought back, given the strength of this liquidity dynamic.
It's very difficult to predict Aditya, but could the extent of the drawdowns be shallower? Are you putting percentage terms to this? I know it's hazardous to lay out a guess, but I'm still trying to understand?
Aditya Suresh: I think it's hazardous. I think that's kind of our position as well.... I can get my head around trying to price something based on return on equity growth, therefore the multiple should be x, and then trying to make sense in terms of how much downside there is and so on and so forth.
But really what we speak about is significant compression of the cost capital, and that compression of cost capital, because domestic equity is having this profound valuation impacts, and we are calibrating as we go, rather than actually calling for a specific drawdown, rather than calling for specific drawdowns.
Wwill ask Aditya Suresh about the significance of a comparatively higher ROE for Indian firms versus rest of Asia and what would that lead foreigners to do in the event of a correction, despite the higher valuations, I think that's something that I'm looking forward to hearing from Adiya Suresh and would love to understand what is the significance of this higher ROE that India enjoys because we know that during the past decade a lot of commentators have said that was a principal reason why India used to trade at a premium. Is this still a key reason for why India could stay at a premium and therefore in the event of a correction, could this be one of the drawing factors as well?
Aditya Suresh: So just to explain the graph again, what we're showing you is, again, forward ROE expectations for consensus and the point which we make is that in terms of an outlook, we are as a market set improved from a 12% ROE outlook towards about a 16% number which is constructed/ consorted.
Now the significance of this is, as what you're pointing out, which is that I think quality stands out. So quality stands out as a support factor, and in particular, as a factor. It really stands out in the event of pullbacks movement globally. So I think this would be a key characteristic which continues to be in India's favour, when, you know, overlay the fact that you have growth in the market as well, a lot of themes, so on, so forth. This entire quality compounding characteristic for the overall market will, again, I think, be a support factor here for us.
Now, just on the premium in itself compared to emerging markets, today it is about 300 basis points by that, what I mean is, if India is at 16% emerging markets, the expectation is about, say, 13% that 300 basis points premium in itself is not too dissimilar from history, though. So whilst it is a support factor? Is it an explanatory factor to suggest why India is sitting at 22 times three or four multiples? It's not. So it goes into the mix, but just on growth, just in returns.
These are helpful but they don't really tell you the full story. It comes back to at least empirically when in the note, we can go through this in detail, is that just in growth, just in returns, just in foreign flows, we can't really defend why as a market should be at these levels. But then when you kind of think about the domestic liquidity piece, it then kind of comes together, and we can get these valuations to start to make more sense.
Okay, agreed, it's a mix. Obviously, it won't be a single biggest factor, but as important, I mean, is that a strong enough, important reason, coupled with the fact that now, again, as one of the other charts in your report shows India's weightage in the EM basket as well for passive flows too. Much higher than what it used to be. The differential is much lower versus China. So whenever the EM flows gush back, presumably post the rate cut or otherwise. Does that also aid the probability of flows? So higher ROEs, more weightage, stable earnings growth. Does all of this auger well for flows? I'm just trying to understand from somebody who looks at this more closely and is more informed than most people about when do foreign flows make a comeback?
Aditya Suresh: But I think that's exactly it, right? So I don't think India on its own, at least in terms of foreign liquidity dynamic, going back to 2023. Yes, we saw a lot of flows coming in. But the backdrop was that EM X China as a group, saw a lot of inflows, and within that we saw greater capture of those flows.
So I think the starting point has to be that EM X China as a category is going to see more inflows and within that, I think India will continue to stand out as a benefactor of these flows. But I think as a category, as a group, we've got to see the influence first. I don’t think India, on its own, is going to see foreign allocations expanding, at least from foreigners.
Okay. Aditya, where do you think money flows in? I mean, what are the top sectoral thematic bets that Macquarie is laying out at the current valuations?
Aditya Suresh: So, if the question is about the foreigners, then the problem has been that.
Actually, the question is really about what is in your head? What is it that you think are the best bets? I don't know if you are essentially looking at strategy, looking thinking about those lines, but if you are, would love to know that.
Aditya Suresh: So when you kind of tie all this back in to the bottom up, thinking about what's in earnings, expectations, where is the risk, sort of what, as a general point, what I'll make is that we're finding that sector, type of top down call much harder to take today than what we're seeing a couple of years back, where we could have given you some view about financials and industrials, all these things.
Today, at a point in time, we're not seeing clearly any of the sectors where earnings estimates are going to be revised upward. So, if I was using that as a proxy to think about where we should be incrementally positioned over the next eight–12 months, our honest submissions, and across sectors, estimates are full.
Within that backdrop, then it becomes part where, in relative terms, we see or have a bit more confidence compared to consensus on how these estimates could shake up, and that they overlay valuations as well. So the private sector banks look very interesting given the steep valuation disconnect here. Whilst we still think that there are compounding characteristics. Beyond that, I think the telecom sector has done well.
I still think there's a path where the incremental returns are going to meaningfully improve over the next two, three years. The IT sector, I think, is one where, if anything, probably a bit more optimistic than where the street is at on both the recovery as well as margins. That's kind of one-way positioning is relatively mild as well. So, if you want a contrarian kind of is more the IT space where we would be allocating. But I think the real message, which I wanted to give you was that it's more bottom up, specific stocks and then aggregating it up, rather than, rather than starting with a view that I want to be overweight Financials or I.T. or Industrials.
Points well noted. Anything that you believe. I mean, where there is a clear case of caution warranted, I mean, we were covering one of the investor conferences, and one of the summations was that rural demand is picking up, urban is slowing down. Are you guys kind of thinking on those lines as well, and are there investing implications thereof?
Aditya Suresh: I think consumer as a space, we have remained cautious for some time and given where expected earnings expectations are at, I think there are disappointments to potentially kind of work through, for example, as a case in point with the auto sector. When you kind of look at estimates, what's in estimates is volume growth, operating leverage, marginal expansion. That is kind of an outlook of the next, say, couple years, on a real-time basis.
What we can clearly see is inventory levels increasing, and in response to those inventory levels, you're seeing kind of price action and price cuts. That clearly speaks to downside to earnings estimates. So I think just kind of a case in point, as you speak, about consumers. I think that's an area where we are remaining cautious. If there is any position, it's very selective bottom up.
Even the rural dynamic, it's not amply clear to us how much of this is actually going to sustain the next six months, 12 months. Data is not as yet fully formed and supportive. I think, for now, it's still a view that we think conditions have improved, hopefully it sustains. But when I look at say is real rural wage growth as a proxy for this. That's still soft. If you really need that pickup for us to get a little more confidence in this rural recovery story.
