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Independence Day

Without much ado, and without too many people noticing, the FIIs' dominance of the Indian equity markets is ending

Independence Day

"In movies: Beta ro mat, nahin to gabbar aa jayega. These days: Beta short mat kar, nahin to domestic mutual fund manager aa jayega." So tweeted renowned investment manager Samir Arora from his perch in Singapore a couple of days back. It sort of brings up a mental image of the swank office of a hedge fund with Gabbar Singh and Sambha discussing their emerging markets strategy across the CEO's table. That's an idea for someone who does voiceover comedies on YouTube.

However, like most good jokes, this one is funny because there's a big element of truth in what it says. Once upon a time, it was almost a truism that Foreign Institutional Investors (FIIs) drive the Indian markets. For traders, the highest form of market research used to be to figure out what FIIs would do next. However, those days are largely gone. FIIs may be important but only in the sense that all investors are important. Moreover, foreign as well as domestic fund managers are acutely aware of how the balance of power has shifted over the years.

What is to account for the domestic investment manager's new found power? The root cause is that earlier, only the fickle rich were investing in equities. Now, the steadfast middle class also does. Sounds strange? But it's the truth. The archetypal Indian equity investor was a rich person, or, in the jargon of those who sell things to the rich, an HNI--High Net Worth Individual. The equity investment that this sort of an investor does is short-term trading, buying and selling stocks and derivatives in a matter of days or weeks, trying to make quick bets based on guesses on what the markets would do. When the FIIs sold and fled, the HNI also did because that was what made sense for the short-term trader. I hope it doesn't sound like I'm blaming someone here, because I'm not.

Let's talk about the steadfast middle class now. There are three routes which middle class money is taking to the markets. One is investors' own SIP investments, the second is the equity investments from the Employees Provident Fund Organisation (EPFO), and the third is the equity investments of the National Pension System (NPS). SIP investments in equity and hybrid funds now total an inflow of about R 2,000 crore a month. Unlike HNIs' trading which rapidly ebb and flow with every hiccup if the market, SIPs keep flowing, regardless of the fact that equities have been broadly stagnant for long periods of time. SIP volumes have grown steadily, as everyone who invests through SIPs ends up having a good experience, unlike the HNI punters.

Let's come to the EPFO now. During 2016-17, the EPFO has been investing in equities at a rate that will bring the financial year's total to about Rs 13,000 crore. That's 10 per cent of its incremental investments, which is the current norm. Even if this stays at the same level, natural growth will likely see next year touch Rs 16,000 crore. What is distinct about the EPFO investment is that it will keep flowing in at an increasing rate no matter what happens.

The nature of NPS flows is also somewhat similar. I don't have the precise incremental numbers specifically for equity because it's not a uniform percentage as in the EPFO's case. NPS may not have lived up fully to its potential yet but its accumulated corpus is already Rs 1.66 lakh crore. Around 15 per cent of this is probably equity. Like EPFO, NPS inflows will only increase with time and will always keep flowing, month after month, regardless of market conditions. Moreover, the outflows will always be modest, predictable and a tiny fraction of the inflows.

Now you see what I mean by steadfast middle class money? This steady pattern of drip-investment will produce far better returns than the skittish HNI ever manages to earn. It will produce a whole generation of investors who have tasted success as equity investors. FIIs will alway invest in India but their dominance is ending, and in the best way possible.