When Will FIIs Return to the Indian Stock Market? Bernstein Answers

Foreign institutional investors may return to Indian equities over the next 12 months, but Bernstein expects the shift to be more tactical than a return to sustained long-term investment. 

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Foreign investors have withdrawn nearly $40 billion from Indian equities over the past two years. Bernstein expects FII flows to remain flat to modestly positive over the coming 12 months, largely because some of the pressures behind the recent outflows are easing. 

The brokerage, however, does not see a significant change yet in the structural factors that determine long-term foreign allocations to India. 

Two years of outflows reshape the FII picture 

Bernstein’s assessment comes after a prolonged period of foreign selling from Indian equities. 

The brokerage noted that the Nifty has delivered annualised returns of around 6% in US dollar terms over the past decade, while annualised returns over the last two years have been close to negative 11%. 

Against this backdrop, Bernstein sees limited grounds for a substantial long-term allocation by foreign investors at present. 

Instead, the brokerage believes overseas investors could return to Indian equities for shorter-term opportunities as market conditions change. 

FII and DII flows have followed cycles 

Bernstein also pointed to a historical pattern in institutional flows into Indian equities. 

According to its analysis, foreign investment has typically seen periods of inflows lasting two to three years, followed by about a year of subdued activity. These quieter periods have generally coincided with domestic institutional investor flows reaching stronger levels while FIIs either booked profits or held back fresh capital. 

FII flows have historically peaked at around $25 billion a year, while DII flows have reached roughly $15 billion to $20 billion annually. 

There have been fewer periods when both foreign and domestic institutions were significant buyers at the same time. Bernstein cited 2023 as the most recent example. 

Large-cap growth remains a concern for Bernstein 

The composition of India’s large-cap universe is another issue highlighted in the report. 

Bernstein’s assessment is that many large companies are focused more on consolidating their existing businesses than investing aggressively in newer areas of economic growth. 

The brokerage pointed specifically to electric vehicles, semiconductors and solar as areas where India has struggled to scale, linking this partly to limited capital commitment from companies with substantial financial resources. 

This creates a challenge for foreign institutions seeking large, liquid companies capable of delivering growth from emerging industries. 

Small and mid-caps bring a different set of challenges 

If large-cap companies do not provide enough growth opportunities, foreign investors could look towards small and mid-cap companies. 

Bernstein, however, sees practical limitations here as well. 

Many companies in this segment remain relatively small, with limited free float, lower liquidity and sparse research coverage. Identifying companies capable of growing into larger institutional investments can therefore require specialist teams, longer investment horizons and dedicated resources. 

The brokerage also noted that flows into these stocks can be driven heavily by news, while disappointing quarterly performance can lead to sharp changes in market sentiment. 

By the time some companies become large and liquid enough for institutional investors, a considerable portion of their earlier value creation may already have taken place. 

AI trade reversal may not automatically bring money to India 

Bernstein also examined whether a possible peak in the global artificial intelligence trade could redirect international capital towards Indian equities. 

Its assessment suggests that such a shift alone may not be enough to generate sustained foreign inflows into India. 

The brokerage believes a more durable revival in overseas investment would require India to develop globally competitive businesses in emerging industries. 

It identified advanced semiconductor manufacturing, rather than only assembly, along with batteries and energy storage, greater energy self-sufficiency and businesses capable of securing meaningful global market share as areas that could influence structural foreign investment. 

For the next 12 months, Bernstein’s base view remains limited: FII flows could move from heavy withdrawals towards flat or modestly positive levels, but a broader return of long-term foreign capital would depend on deeper changes in India’s corporate and industrial landscape.