Much to our amazement, foreigners have poured in over $24 billion in 2012 to create a sharp rally in India. Since as much as $1.8 billion were pulled out of India-focused funds and ETFs, a Morningstar report gives an interesting take as to where the money came from in 2012 to create the sharp rally

Braving macro-economic negatives and policy paralysis last year, Foreign Institutional Investors (FIIs) poured over $24 billion into India in 2012. Indeed, India got its second largest inflow of funds in 2012. But since data about foreign investment is opaque and India is agnostic about sources of money, nobody knows which kind of funds have invested in India more. Where did the money come from? From hedge funds? From ETFs? From “India-focussed” funds (i.e. foreign banks and asset management companies set up funds with sole focus on investing in India for their investors)? Apparently none of these, if Morningstar, a fund rating company, is to be believed.
 

To make the Indian rally and the torrent of inflow even more mysterious, Morningstar, now shows that India-focused offshore funds and Exchange Traded Funds (ETFs) had registered a cumulative net outflow of $1.8 billion during 2012. A lot of sceptics believe that the money is being round-tripped into India. India money, (mostly ill-gotten), taken out of India, is coming back.
 

Since this cannot be proved or denied, here is the rationalization. According to Morningstar, the global economic situation last year prompted investors to switch from developed markets and look elsewhere. Two key events last year—the “Fiscal Cliff” and the possible break-up of the Euro Zone—prompted investors to look elsewhere. India was one of them, but money came here in a very different way—from “emerging market funds”. The quantitative easing in America and the sovereign bailouts in Europe prompted money to fly out of their domiciles and come into emerging and frontier markets funds as an alternative, as returns were better in India and similar markets. According to Dhruva Raj Chatterji, a senior research analyst with Morningstar, “One big contributor of flows into India in 2012 have been emerging market stock funds. These funds have a decent allocation to India in their portfolios, and have registered huge inflows from investors during 2012.”

According to Morningstar Asset Flow data, US Diversified Emerging Markets Funds and ETFs together registered the second highest ever annual inflows of almost $49 billion during the year 2012, with the highest inflow being $56 billion recorded in 2010. Similarly, funds and ETFs belonging to the Morningstar Global Emerging Markets Equity category in Europe registered a net inflow of €11.66 billion up to November 2012. One of the most prominent index funds—Vanguard Emerging Markets Stock Index Fund—which is an index fund with assets in excess of $75 billion at the end of 2012, saw its India allocation go up from 5.5% at the end of 2011 to 7.2% at the end of September 2012. Other prominent funds which featured India in their allocation were iShares MSCI Emerging Markets Index Fund, Oppenheimer Developing Markets Fund, Vontobel Emerging Markets Equities, and Aberdeen Global Emerging Markets Equity. “With a partial allocation to India in several of these fund’s portfolios, the country has been an indirect beneficiary of inflows into these funds,” said Chatterji in his Morningstar report.
 

With the perfect benefit of hindsight, Morningstar data suggests that FIIs preferred to diversify through emerging market funds rather than focus directly on India which was hampered by corruption, delayed policy making, coalition politics and mud-slinging apart from inflation.