FII Flows Could Return in 2026: Markets Not Pricing in the Upside Yet
Insights from Vikas Khemani on Market Dynamics
Agencies report that while domestic institutional inflows are bolstering the market, participation from foreign investors has been inconsistent. Vikas Khemani, from Carnelian Asset Management, predicts this will improve as global conditions shift. As Indian equities navigate a consolidation phase amidst uneven global flows, savvy investors are increasingly favoring bottom-up stock selection over market-cap or thematic strategies.
The Role of PSU Banks
– Khemani is optimistic about the inclusion of public sector undertakings (PSUs) in investment portfolios, particularly PSU banks.
– Absolutely, he asserts. We have been holding PSU banks for some time now. They are remarkable franchises that have undergone significant transformations in asset quality, technology, and governance, differing vastly from their state a decade ago.
– Many PSU banks are still delivering return on equity (ROE) between 15% and 18%, even showing promising growth post-consolidation.
Market Allocation: Stock-Specific vs. Market-Cap
The debate continues over whether to prioritize market-cap allocation or stock-specific investments. Khemani emphasizes the importance of liquidity for fund managers, but ultimately, earnings visibility and valuation comfort drive returns.
– Our methodology has always centered around bottom-up approaches. If a stock demonstrates sustainable earnings growth of 15-20% over the next three to five years at a reasonable price, we are keen to invest, he notes.
– Short-term underperformance doesn’t faze us if the long-term narrative holds true.
Despite the significance of macro and sectoral tailwinds, he insists that focused stock selection remains paramount.
– It’s crucial to balance top-down and bottom-up approaches, but if forced to choose, bottom-up will always prevail.
Perspectives on IT Services
Amid ongoing discussions about artificial intelligence (AI) and currency fluctuations impacting the IT sector, Khemani takes a contrarian viewpoint.
– Concerns about disruption are likely exaggerated. Historical technology transitions — from Y2K to cloud computing — have expanded opportunities for Indian IT services. AI will be no exception.
– Firms will still rely on IT partners for implementation, data organization, and tool selection, making it a mistake to disregard the sector entirely.
– While not every IT company will thrive, the sector as a whole is poised for growth, with robust order books and ongoing deal wins.
Manufacturing Opportunities
Khemani also suggests that manufacturing should not be treated as a monolithic theme.
– It encapsulates everything from chemicals and auto components to defense and capital goods. We are particularly optimistic about select specialty chemicals, auto components, contract development and manufacturing organizations (CDMOs), capital goods, and power ancillaries, where we foresee sustained medium to long-term growth.
Future Expectations and Market Flows
Although domestic institutional inflows continue to provide robust support, foreign investor participation remains erratic. Khemani predicts this will change as global conditions evolve.
– Domestic institutional investor (DII) inflows have been strong, largely driven by steady systematic investment plan (SIP) inflows.
– He anticipates a rebound in foreign institutional investment (FII) by 2026 due to decreasing US interest rates, which may draw attention back to emerging markets. The China–India rebalancing trade is largely behind us.
– Notably, Indian markets have shown resilience despite persistent FII outflows, signifying a positive outlook. If FII flows turn positive, their impact could be substantial. Currently, markets are not pricing in this potential upside, which could lead to a significant rerating.
Conclusion: The Path to Long-Term Wealth Creation
The overarching takeaway from Khemani’s insights is clear: while macro variables and global flows can influence market sentiment, the ongoing wealth creation in Indian equities will ultimately depend on disciplined stock picking, patience, and a strong commitment to understanding business fundamentals. This disciplined approach will be essential as FII flows potentially shift in favor of the market by 2026.