LONDON/MUMBAI May 15 With emerging equity funds positioned for a business-friendly outcome to India's election, any further boost for the pumped-up stock market may come from global funds whose India allocation still has room to grow.
Election results due on Friday are expected to reveal a strong mandate for the opposition BJP, seen as more pro-business than its rivals. Those expectations have fuelled year-to-date stock market gains of 14 percent and a 4 percent rise in the rupee's exchange rate against the dollar.
Foreigners betting on a BJP victory have poured more than $16 billion into Indian stocks and bonds in the past six months and now hold over 22 percent of Mumbai-listed equities - a stake estimated by Morgan Stanley at almost $280 billion.
But does the market have room to rally further?
The short-term answer is yes - a majority for the BJP, as indicated by this week's exit polls, will bring more gains. Societe Generale, for instance, predicts Mumbai stocks currently at 23,800 points will hit 25,000 if a big BJP win materialises.
Funds dedicated to emerging equities may be running out of room to extend positions, however - they currently run a record 600 basis-point overweight on India, Morgan Stanley estimates.
That means India comprises a much bigger share in portfolios than its 6.8 percent weight in the MSCI emerging markets index.
That is borne out by other data. Bank of America/Merrill Lynch's monthly survey showed India is the biggest overweight for emerging market funds, while emerging equity funds tracked by Boston-based EPFR Global have an average 9 percent allocation to Indian stocks.
"Positioning is certainly a reason to be wary; the marginal foreign buyer going forward will need to be more global than Asian or emerging market dedicated portfolio managers," Morgan Stanley said, advising emerging market clients to stay neutral.
Despite predicting post-election gains, Societe Generale also told clients this week to "rotate out of India" for what it called more attractive opportunities elsewhere in Asia.
But positioning by funds with a global rather than an emerging markets mandate is less extreme - Goldman Sachs calculates they hold a smaller 130 bps overweight on India.
These funds, which have a broader pool of stocks to choose from, have held off from buying into the India election story, possibly daunted by the scale of challenges facing the new government and India's poor track record on reform.
Valuations, too, are not alluring. Growth is well off the 8-9 percent rates of some years ago, and company earnings are weak, yet shares trade at 14 times forward earnings, in line with long-term averages.
One of many global investors that is neutral on Indian equities is ING Investment Management. That means it is holding allocations level with India's share in equity indices - in the MSCI all-country index, which includes developed as well as emerging economies, India's weight is a tiny 0.7 percent.
"We need a very good result to get more upside, an environment where the BJP can push through all the reforms that are needed. I am not convinced," said Maarten-Jan Bakkum, investment strategist at ING IM.
Yet global funds' assets dwarf the amounts managed by dedicated emerging funds - MSCI, the most widely used index provider, has $8 trillion benchmarked to its indices worldwide but only $1.3 trillion of that tracks emerging indices.
So even a tiny allocation shift by global funds would bring billions of dollars into the market.
Meanwhile, Indian funds, suffering redemptions by jittery retail investors, have dumped shares worth 98.5 billion rupees ($1.67 billion) in 2014, the third year of outflows, regulatory data shows. That brings their share of the market to a six-year low, according to Mumbai-based Motilal Oswal brokerage.
Goldman Sachs reckons a convincing opposition win would bring in these buyers as well as more globally oriented funds.
"Global funds still have very low allocations in India, and we continue to see global funds and longer-term investors increasing their allocations in this market should fundamentals improve as we expect," analysts at the bank said.
Some may feel a sense of deja vu, however. Indian stocks jumped 18 percent on May 18, 2009, after the Congress-led alliance won enough parliamentary seats to avoid a coalition with anti-reform parties.
But that was their high point for years amid disappointing progress on reforms and a raft of corruption scandals.
This time, markets may have priced not just a BJP election win but also swift reforms and a return to double-digit growth.
"The BJP may provide strong leadership, and a strong prime minister is what India has been missing. But until roads and power capacity are built, we can't dream of 8 percent growth," said Steve O'Hanlon, a fund manager at ACPI Investments.
Indian markets have room to rally, O'Hanlon reckons, but he bases his view on the improved balance of payments deficit and trust in the new central bank governor to bring down inflation.
"I don't think the story changes that much (post-election), India has turned the corner in terms of policies," he said. (Additional reporting by Vikram Subhedar in London; Editing by Catherine Evans)