For almost a decade now, when foreign investors first started investing in India, it has been a truism that bull runs in India have been driven by foreign money. Sure, there have been some phases when investments from domestic sources have been as large as or even a little larger than those by FIIs but that doesn't really affect the argument. If you remove the FIIs' demand for the stock of any company where they've been, then the upward pressure on the price cannot be maintained by domestic buyers alone.
However, unlike the impression one often gets in India, foreign investors' views on Indian stocks are not a single, unanimous and monolithic opinion. For quite a while now, there are foreign investors who think Indian stocks are overpriced and the average PE of Indian stocks is much higher than that of other emerging markets. There are research teams in large, well-known foreign banks and broking houses-some of them the biggest names in the business-who have had a 'sell' rating on India since about the time the Sensex was around 5,000. On the other hand, there are others who have robust buying plans even with the Sensex at 13,000. These are two opposing camps, each of which have an apparently sound set of arguments.
A couple of weeks ago, I happened to have a long conversation with Samir Arora, a very successful fund manager who had an interesting insight into this issue. Arora used to manage the erstwhile Alliance mutual funds in India and now manages a foreign India fund named Helios from Singapore. Arora thinks that those who are bearish on India are looking at superficial numbers without going deeper into things.
For example, many foreign fund managers start at a high level by deciding their emerging market allocation and then apportion this by using an emerging markets index, the most popular of which is Morgan Stanley's MSCI Global Emerging Market Index. However, this index is seriously underweight on India. India's share in this index, as a ratio to either the total market capitalisation of the stock market, or size of the economy is lower than that of almost any other country. Korea has 17.5 per cent of this index while India has 6.7 per cent while the two countries' stock markets have roughly equal market cap and roughly equal GDP. Taiwan has twice India's share in the index with a lower market cap and a smaller GDP.
The story about India's supposed expensive (high PE) markets is also similarly distorted at a superficial level. There are sectors, which are inherently high PE and there are sectors which are inherently low PE. Typical examples of high PE sectors are software and services and of low PE sectors are energy, utilities and electronics hardware. As it happens, when compared to practically every other country in the index, India has more high PE companies and fewer low PE companies. It's not as if India's energy stocks are more expensive than Russia's energy stocks, but Russia's index is 76 per cent energy and zero per cent software while India's is 16 per cent energy and 21 per cent software. Similarly, Korea's index is 30 per cent electronics hardware, while India's index is zero in this sector.
The fact is that the India story cannot be understood by looking at some quick top-line numbers. Averages and trends are made up of individual numbers and unless one understands those, the broad numbers are more likely to be misleading than illuminating. Here's how a joke about averages goes. Bill Gates walks into a bar and suddenly everyone in the bar becomes a billionaire. On the average. Bill Gates being in that bar is just like Infosys being in the Sensex.