Equity Strategy: Restricted entry

Updated: Jul 28 2014, 06:14am hrs
The foreign investible Indian universe looks quite different from the marketable universe. Many prominent stocks on the CNX Nifty 50 are restricted for foreign investors. Foreign institutional investors have already used 75-80% of the permissible FII limit in cyclical sectors like consumer discretionary, financial and industrial sectors. The industrial sector may face FII headroom concerns as sector rotation from defensive to cyclical stocks and capital inflows reduce the available FII limits in top-tier companies.

Exposure to sectors substantially different Foreign headroom has been a big concern for many CNX Nifty 50 companies in recent times. Reserve Bank restrictions on many blue chips have prohibited incremental FII buying. In fact, half the constituents of the CNX Bank Nifty Index are restricted to FIIs, limiting top-tier investment options in the sector. Global benchmarks (and subsequently exchange traded fundsETFs) have taken heed and rebalanced their benchmarks to exclude constituents inaccessible to foreign investors. This has resulted in a substantial divergence in sector allocations by the MSCI India (investible) compared to the CNX Nifty 50 (marketable).

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MSCI India exposure to financials 10% less than the CNX Nifty 50 Financials constitute a major portion of the CNX Nifty 50 (30% of allocations). In comparison, the MSCI India Index has only 20% exposure to financials, preferring sectors like information technology and healthcare. This has led to (i) higher valuations for the investible benchmark (MSCI India Index) than the CNX Nifty 50 due to preferred sectors being relatively more expensive than banking and (ii) passive investments (ETFs) favouring information technology and healthcare over financials. Although fresh equity issuances in the banking sector may assist in increasing free-float, foreign ownership limits of 20% in the PSU segment will mitigate positive implications for the stocks.

Heavy on foreign capital60% of FII investable equity has been bought

FIIs own 23% of the outstanding equity in the CNX Nifty 50. On a free-float basis, this amounts to 45% of the total shares in value terms. In the case of foreign investors, free-float is not synonymous with investible equity shares because foreign ownership limits govern the availability of each constituent. Cyclical sectors such as consumer discretionary (80%), financials (77%) and industrials (74%) have used up most of their available FII limit. This implies foreign investors can incrementally buy only $2.2 bn in the industrials sector within the CNX Nifty 50. In contrast, energy has available foreign headroom worth $35 bn.

Current investment pace may cause FII headroom concerns in industrials

FII sector-wise assets under custody have been showing reallocation from defensive stocks to cyclical stocks since August 2013. FII capital flows in June suggest sector rotation is underway with outflows continuing in the information technology and consumer staples segments. We believe further sector rotation in the blue-chip segment may be hindered due to foreign ownership constraints. Based on average annual FII inflows, top-tier industrial stocks may be inaccessible within a year. Although the CNX Nifty Junior constituents may provide some incremental access to the industrials sector, foreign investors have already used 70% of the FII limit.

Kotak Institutioal Equities