Moneycontrol Pro Panorama | Is India an AI hedge trade?

the global investment community's obsession with artificial intelligence (AI) has redirected capital flows towards the United States and China

Dear Reader,

Since reaching their peak in September 2024, Indian markets have remained largely stagnant. Foreign Institutional Investors (FIIs) have maintained relentless selling pressure in Indian equities, a trend notably absent in other global markets during this period.

The impact has been striking. The Nifty 50 index now trades at nearly a 20 percent valuation discount to the S&P 500, approaching the widest gap seen in the past 17 years. This marks a dramatic reversal compared to historical levels, as Indian markets have traditionally commanded a premium over their American counterparts. What makes this discount particularly remarkable is its duration-- now extending into its 23rd month, representing the longest such period since 2006.

Beyond valuation concerns, India has suffered a sharp decline in investor sentiment. The country has fallen from grace among global emerging-market (GEM) investors, becoming a least favoured destination. According to analysis done by HSBC, India now holds the dubious distinction of being the biggest underweight position in GEM portfolios, with only a quarter of tracked funds maintaining overweight allocations to the country.

India's benchmark weight in the MSCI Emerging Markets Index has slipped to 15.25 percent—a 2-year low. The widespread underweight positioning means fund managers are allocating less than this benchmark percentage to India in their emerging market portfolios, a stark contrast to just a year ago, when India was the top pick among emerging markets.

This dramatic fall can be attributed largely to sustained FII selling totalling approximately $30 billion over the past 12-13 months. The exodus has resulted in India underperforming emerging markets by 27 percentage points year-to-date—the largest such gap in two decades.

Several factors have driven this foreign capital flight. Indian corporate earnings have weakened amid global economic headwinds, including uncertainties surrounding Trump-era tariffs. Meanwhile, the global investment community's obsession with artificial intelligence (AI) has redirected capital flows towards the United States and China, where AI revolutions are underway. With few Indian companies engaged in front-end AI development, funds have naturally gravitated elsewhere.

However, the tide may be turning. Many fund managers and market experts are now cautioning that AI investments have become overcrowded, with companies trading at near-bubble valuations. Overheating in AI stocks could signal an opportunity for India.

Indeed, there are emerging signs that FII selling may be nearing its end, with research firms beginning to reconsider their stance on India. Several broking houses have started recommending Indian investments. Both HSBC and Goldman Sachs have recently adopted bullish positions, shifting to "overweight" recommendations on India.

Herald van der Linde, HSBC's head of equity strategy for the Asia-Pacific region, offered a compelling rationale: "We see India as a useful AI hedge and a source of diversification for those uncomfortable with the AI frenzy."

Goldman Sachs echoed this optimism with a forward-looking perspective: "We now see a case for India to perform better next year, with growth-supportive policies, earnings revival, supportive positioning, and defensible valuations."

As the pendulum of global investment sentiment swings, India may be poised for a comeback after weathering one of its most challenging periods in recent memory.

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