Jefferies Highlights Robust Domestic Equity Inflows Amid Rising Risks

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Jefferies Highlights Robust Domestic Equity Inflows Amid Rising Risks
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In 2024, domestic equity inflows in India have soared to over $7 billion per month, nearly double the previous peak and more than triple the amount from the same period last year. This surge is driven by domestic investors positioning themselves for favorable election outcomes.

However, with these inflows now accounting for around 20% of financial savings and predictable flows making up less than half, there is a growing risk of a reversal in domestic investments. Potential regulatory actions on derivatives could trigger such a shift. Foreign portfolio investors (FPIs) are expected to buy the dips, thus limiting the downside for large-cap stocks.

Analyzing the Inflow Components

Net retail inflows into the Indian markets are trending at approximately $7 billion per month from January to May 2024. These inflows can be categorized into four main components:

1. Direct Retail Trading: Net retail flows into direct equities via NSE have amounted to around $8.8 billion.

2. Discretionary Mutual Fund Flows: Excluding systematic investment plans (SIPs), mutual fund inflows have reached $5.8 billion.

3. SIP Inflows: These have contributed $9.3 billion.

4. Other Sources: Flows from the equity component of insurance and other sources total $6.4 billion.

Of these sources, direct retail trading and discretionary mutual fund flows are highly volatile and driven by market sentiment. In contrast, SIPs and the equity portion of pension schemes and insurance are more sustainable, accounting for about $40 billion annually, or slightly under half of the current domestic flow pace.

For FY24, financial savings flow is estimated at $375 billion. Assuming a 10% growth, equity inflows at the current pace will constitute around 20% of financial savings this year, compared to an average of 6% over the past decade. Indian household asset holdings show equity as a proportion of total assets at approximately 6%, indicating a strong structural shift towards equities and financial savings. However, the recent sharp increase in equity inflows may decelerate.

There has been a significant rise in futures and options (F&O) turnover, with daily notional trades hitting $5.3 trillion, more than double the Indian market capitalization and triple the FY23 average. Although the premiums paid are lower at $8.1 billion per day, they are still 20 times higher than pre-COVID levels. Regulators are concerned about this heightened derivatives activity, and any regulatory action could reduce derivatives volumes, potentially impacting small and mid-cap (smidcap) stocks. Notably, 36% of direct retail money is concentrated in stocks outside the top 100, compared to 20% for FPIs.

Open interest analysis in stock futures indicates significant long build-ups in select midcaps and public sector units (PSUs), likely driven by retail investors. These stocks, having shown strong performance, are vulnerable to potential retail unwinding. In contrast, large caps in IT, private banks, and the consumer sector have seen short build-ups, possibly driven by FPIs, and may experience a bounce due to sector rotation.

FPIs have been net sellers in India by $2.7 billion year-to-date, with their relative positioning now close to neutral. Traditionally, FPIs favor larger caps, and any dip in the Indian market caused by a reversal of domestic flows could benefit larger caps, leading to their outperformance.

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