Betting big on India: Thomas Gerhardt of DWS Investments

$ 49 billion (Rs 2.205 lakh crore). That's the quantum of greenbacks that have cascaded into the country's equity markets since the by-now-ubiquitous foreign institutional investor (FII) tribe first checked into the country in 1992. And more than half of those inflows-some $28 billion (Rs 1.26 lakh crore)-have been invested in the past 35 months, making India one of the hottest destinations for foreign investible money-it's only in Japan (it attracted $260 billion or Rs 11.7 lakh crore between 2004 and November 2006) and Taiwan ($45.6 billon or Rs 2.052 lakh crore) that global portfolio investors have pumped more of the moolah.

With the FIIs clearly ruling on Dalal Street-estimates indicate that FIIs are investors in at least 1,000 Indian stocks-it's common to look at their mammoth inflows as a homogenous mass of invested wealth. That's far from the truth of course with, at last count, some 993 FIIs registered with the Securities & Exchange Board of India (SEBI), and another 2,938 bodies investing via the sub-account route through registered FIIs. But, as data put together by BT reveals, it's a handful of global investment houses that accounts for a chunk of the FII inflows into Indian equity. According to Emerging Portfolio, a global fund data provider and research firm, the top 10 funds that invested in India have a corpus of $13.6 billion (Rs 61,200 crore). Heading that list-as per data collated by BT from market sources-is HSBC, handling nearly $8 billion (Rs 36,000 crore) of foreign money in India (see The Big Boys' Club). HSBC is followed by JP Morgan, Fidelity, Merrill Lynch, DWS and UBS in that order, each of which handles between $5 and $7 billion (Rs 22,500-31,500 crore).

Some of the men responsible for those billion-dollar allocations would be familiar names in Indian market circles. Ruchir Sharma, Head (Global Emerging Markets), Morgan Stanley, is based in New York, from where he drives his firm's India allocations. Sanjiv Duggal till recently was Chief Investment Officer (CIO) at HSBC AMC. He has since relocated to Singapore from where he oversees hsbc's India-dedicated funds. Duggal handles one of the largest India-dedicated offshore funds in the world, which boasts a corpus of $5.8 billion (Rs 26,100 crore). Says Duggal, Investment Director, HSBC Capital Market Management, Singapore: "The offshore fund predominantly invests in large-cap stocks that are listed in India or derive substantial revenues from India operations." HSBC gif's top 10 India holdings aren't unpredictable, with ONGC, HCL Tech, Maruti Udyog, Infosys, Hutchison Telecommunications-which derives nearly half of its revenues from its Indian operations-Mahindra & Mahindra, Grasim, Reliance Communications, ICICI Bank and Bharti Airtel making up that list. These 10 stocks account for 31.4 per cent of HSBC gif's total corpus. "The process and the philosophy of investment differs from region to region...For us any company whose market cap is over Rs 3,500 crore is a large-cap stock. We also invest up to 12.5 per cent in mid-cap and small-cap stocks."

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Funds like the $2.1 billion (Rs 9,450 crore) Aberdeen Capital India Opportunities Fund, the $1 billion (Rs 4,500 crore) Morgan Stanley India Investment Fund and DWS India Fund-managed by Thomas Gerhardt and Robert Kalin-also invest in familiar stocks. In Aberdeen's case, ICICI Bank, Satyam, HDFC and Infosys account for 34 per cent of the fund corpus. Yet that doesn't stop the Luxembourg-based fund from betting on select mid-cap and small-cap stocks. It, for instance, has stocks like Asian Paints, CMC, Aventis, Gujarat Gas, Paper Products, J&K Bank, ICICI, ING Vysya Bank and Godrej Consumer Products in its portfolio. Morgan Stanley India Investment Fund and DWS India fund have 48 per cent and 52 per cent, respectively, invested in their top 10 stocks.

To a large extent, FIIs are most comfortable investing in stocks they can recognise, which is why it isn't unusual to find a sprinkling of the Indian affiliates of global corporations in their portfolios. As Rushabh Sheth, Managing Director, Karma Capital, who manages FII money as well as advises an offshore fund, puts it: "They globally know Unilever, Nestle and Siemens, which is why they initially invest in these known companies. However, once they get familiarised with our market, the money moves into mid-cap stocks." Adds U.R. Bhat, who manages Melchior India Opportunities Fund, a $73 million (Rs 328.5 crore) mid-cap fund: "New FIIs, who have not had an exposure to India, are now entering the equity markets in a big way. They don't know India and thus are buying select index stocks and propelling the index." Bhat adds that for a typical FII, a meaningful allocation is perhaps as important as finding the right company, which is why large-cap stocks inevitably find favour. "On an average, a $1 billion fund will look to acquire 4-5 per cent of a company's equity, which is not possible with a mid-cap or small-cap company," points out Bhat.

Yet, what may be large-cap to most Indian investors won't figure in most FIIs' books as big stocks-remember that the m-cap of Indian markets still makes up just 1.5 per cent of that of all world markets. So, for instance, Gujarat Ambuja Cement, ranked 38 in the m-cap rankings in India with a value of Rs 19,273 crore, figures as a small-cap company in the portfolio of JF Eastern Smaller Companies Fund.

Going forward, FIIs have little choice but to move into the universe of mid-cap and small-cap shares, thanks to limits of FII holdings in certain sectors (for instance, in the state-run banking sector, the FII limit is 20 per cent, and in retail sector, it is 24 per cent). "We primarily invest in blue-chip stocks," says Kalin, Senior Fund Manager, DWS Investments. "However, in the near-term, we may increase our weightage to mid-cap and small-cap stocks from the current 10-12 per cent to 15 per cent. But we will certainly not exceed that as the risk of exiting those counters is high."

Apart from a direct entry into Indian stocks, FIIs use participatory notes (P-notes, which are offshore derivative instruments issued against underlying securities) to mop up domestic equity. That's why DWS Invest BRIC Plus Fund doesn't have a single stock in its top 10 holdings-despite having a 19.4 India weightage! "This is because we have bought the stocks through the P-notes route. We didn't want to miss the opportunity by being late. Therefore, before we could get the FII licence, we started buying through the P-notes. However, in the coming days, we will convert the P-notes to local shares," says Kalin. SEBI, for its part, has been busy approving FIIs, registering one almost every second day. Since May 11, the market regulator has registered 84 new FIIs.

Based in New York, Sharma drives his firm's India allocations Ruchir Sharma Head (Global Emerging Markets)/ Morgan Stanley

Whilst FIIs are perceived to be long-term players-and most of them may well be that-there could be more than a few whose outlook is notoriously short-term. At any given point, nearly 30-40 per cent of the FII money is hot money, which bears higher risk than the long-term money, says Krishnakumar Karva, MD, Emkay Shares & Stock Brokers. "Servicing a domestic mutual fund or an FII is no different. However, you have to keep in mind their mandate before advising them. There are FIIs who only trade in derivatives and some who only take short positions in the derivatives market. For these FIIs, even a marginal (short-term) return is good enough," adds Karva. From the FIIs' point of view, a perennial complaint is the absence of market depth. There may be over 200 companies across sectors with a $1 billion market cap, but many of them are illiquid. "Even in counters like Pantaloon, if you have to pick 1 per cent the overall transaction cost is so high that you eventually end up acquiring the stock 10 per cent higher than the original price," says Sheth. Small wonder then that investors like Kalin say that, more than market cap, what they look for is liquidity. "Stocks like Container Corporation and HDFC are large-caps, but are illiquid counters. I only invest in stocks which have an average daily turnover of m1.5 million (Rs 8.85 crore). This makes our entry and exit very smooth," says Kalin. However, he is not averse to picking illiquid stocks that show long-term promise. "If we identify a stock that has a three-year growth story, we don't mind picking illiquid stocks. In such a case, we go in for a block deal," adds Kalin.

If you're one of those fearing an FII pullout, what with the Sensex hovering around 14,000 and looking overvalued, your fears may be exaggerated. Duggal admits that "at current levels, we are cautious." And Mark Mobius, MD, Templeton Asset Management, Singapore, says: "We find Russian and Brazilian stocks more attractive." But it may not take too long for India to find favour with Mobius once again. Kalin for his part is already looking ahead two years down the line. "Stocks still look cheap on earnings growth of 2009," he says. Indeed the aura of India as one of the most attractive destinations for FIIs inflows is still intact. Says Ajay Bagga, CEO, Lotus AMC: "We are seeing money flowing out of non-performing economies and coming into fast growing economies like India." The FIIs party on Dalal Street appears here to stay.