For much of the past two years, a comforting story has taken hold in India's stock market. Foreign portfolio investors (FPIs) have sold relentlessly; yet, share prices have held up. Domestic mutual funds (DMFs), fuelled by a torrent of systematic investment plan (SIP) money, have stepped in as buyers of last resort. The implication is clear: India no longer depends on fickle foreign capital. Retail investors have arrived, absorbed the shock and stabilised the market.
The numbers appear to support the claim. Since September 2024, FPIs have been heavy sellers, culminating in record net outflows of US$19.6bn (billion) in FY25-26. Domestic institutional investors, meanwhile, bought nearly US$96bn worth of equities. Foreign ownership of National Stock Exchange (NSE)-listed companies has fallen to levels last seen two decades ago, while DMFs have steadily increased their share.
Yet, this popular narrative rests on a questionable assumption—that FPIs and DMFs have been buying and selling the same stocks. Foreign investors remain overwhelmingly concentrated in India's largest companies, while domestic fund flows are increasingly directed towards mid- and small-cap stocks. What appears to be one market absorbing a wave of foreign selling is, in reality, two different markets moving in opposite directions.
The Indian stock market was opened to foreign institutional investors (FIIs) in September 1992. The following year, India's first private-sector mutual fund opened for subscription. Over the next two decades, foreign investors came to dominate the market, while GMFs struggled to build investor confidence. Through the stagflationary 1990s, the dotcom bust of 2001, the commodity and infrastructure boom of 2003-07, the global financial crisis and the subsequent recovery, FPIs largely determined the direction of the Indian stock market. When they sneezed, India caught a cold. At their peak in FY13-14, they owned 22.1% of all stocks listed on NSE.
Throughout this period, concerns were frequently raised that Indians were not participating adequately in the wealth being created by their own stock market. Foreign investors appeared to be capturing a disproportionate share of the gains.
Then something changed. DMFs, whose ownership had remained stuck below 4% for years, began attracting far larger inflows after demonetisation. While foreign ownership hovered around 21%, domestic ownership steadily rose. Following the two-year bull market between September 2022 and September 2024, the divergence became more pronounced. FPI ownership fell to 17.5% by March 2025 and then to 15.8% by March 2026—the lowest level since March 2006. Meanwhile, DMF ownership rose to 10.4%.
The March quarter of FY25-26 highlighted the trend. Of the record US$19.6bn in annual FPI outflows, nearly US$14.2bn occurred during the quarter following Donald Trump's tariff announcements and the Gulf war. Over the same period, domestic institutional investors purchased US$95.8bn of equities. To many observers, this represented a structural shift in India's capital markets. The country had finally developed a domestic investor base capable of offsetting foreign withdrawals. Finance minister Nirmala Sitharaman repeatedly argued that retail investors had become a shock absorber, reducing the market's vulnerability to foreign capital flows. There is truth in that claim. But only up to a point. Aggregate ownership data conceals an important distinction. FPIs remain heavily concentrated in the largest companies. At the end of FY25-26, 92% of their NSE holdings were in the top decile of listed firms by market capitalisation. DMFs were somewhat more diversified, with 87.8% in the top decile and a larger allocation to smaller companies.
The difference becomes clearer when fund flows are examined. During the January-March 2026 quarter, equity mutual funds attracted more than ₹90,000 crore of net inflows. Mid-cap and small-cap schemes alone received over ₹26,000 crore. Large-and-mid-cap funds attracted another ₹11,600 crore. Pure large-cap funds received only ₹7,114 crore, much of it directed towards passive products. Retail investors, in other words, are increasingly allocating capital to segments of the market where FPIs have traditionally had limited exposure. This helps explain one of the curiosities of the past year. Since September 2024, the Nifty 50 has fallen 6.7%. Yet the Nifty Smallcap index is down only 3.8% and the Nifty Microcap index 2.9%. If domestic investors were merely absorbing foreign selling, one would expect similar performance across market segments. Instead, the divergence reflects differing ownership structures and differing sources of demand.
This is not to suggest that FPIs and DMFs inhabit entirely separate universes. Both invest across market capitalisations. But their preferences differ markedly. FPIs remain concentrated in mega-cap banking, software and pharmaceuticals companies, many of which have delivered modest earnings growth. Domestic fund managers, buoyed by relentless SIP inflows, have increasingly gravitated towards fast-growing businesses in pharmaceuticals, defence, precision engineering, power equipment and other mid-cap sectors. The result is that FPI selling and DMF buying have not been mirror images of one another. Foreign investors have largely been exiting one part of the market while domestic investors have been enthusiastically accumulating another.
There is a second and bigger flaw in the argument that retail investors have replaced foreign capital which is in the impact on capital flows and the value of the rupee. When FPIs sell Indian equities, they typically convert the proceeds into dollars before repatriating the money abroad, creating demand for foreign currency and exerting downward pressure on the rupee, as we have seen last year. DMFs, by contrast, deploy domestic savings already denominated in rupees. Their buying may support stock prices, but it does not generate a corresponding inflow of foreign exchange. In other words, DMFs can offset the impact of FPI selling on equity valuations, but they cannot offset its impact on the balance of payments or the currency. This matters because one of the historical concerns about India's dependence on foreign portfolio capital was not merely stock-market volatility but also the risk of sudden pressure on the rupee when foreign investors head for the exits. In short, India has certainly become much less dependent on FPIs than before, thanks to SIPs. But the idea that retail investors have simply absorbed foreign selling is flawed in multiple ways.
Point well taken but nothing reads beyond this. No guess work. No speculation as to what is right and what is wrong. This article is a simple statement of truth which any market expert knows and understands.
On 17 March 2026, during a hearing of the public interest litigation (PIL) filed by this writer on unclaimed financial assets, senior counsel Prashant Bhushan, informed the Supreme Court that the government, had promised that a...
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I didn't read article yet !