How the foreign investors think differently about Indian politics
Unlike more developed markets that predominantly follow the ‘Core’ (less risky) strategy, most India-focused PERE funds follow the ‘Opportunistic’ strategy
Clearly, foreign and domestic investments are differently sensitive to macroeconomic fundamentals. We must not forget that all investors are sophisticated. So, the differing sensitivities to indicators portray differing standpoints to assess the market outlook
Efficient market is a utopia in many spheres of investment. Inefficiencies present predictability and, thus, opportunities for superior capital allocation to the more informed investors. Some markets are less efficient than others wherein information about products and prices does not spread quickly and widely among stakeholders. The issue is particularly acute in relatively less developed markets such as private equity real estate (PERE) in India.
The Indian PERE market is severely underrated in public discourse, but it outperforms its public market (realty stocks) counterpart. Further, India is one of the world's top ten nations in terms of PERE funds launched. Unlike more developed markets that predominantly follow the 'Core' (less risky) strategy, most of India-focused PERE funds follow the 'Opportunistic' strategy in their pursuit of higher returns.
After launch, the fund manager sequentially 'calls' capital from her investors (limited partners: LP). Given limited life of funds (usually 5 to 8 years), identification and closing of deals (i.e., deployment of the raised capital) must be expedited. A deal involves numerous stakeholders beyond buyers and sellers including lenders, lawyers, consultants, and others. A leading indicator of deals may benefit many.
The flow of deals, however, depends on several factors that change over time. In our recent study (published in the Journal of Property Research, Taylor & Francis, UK), we examined if it was possible to predict the PERE deal flows into India using some of the political and macroeconomic factors.
The market experiences more PERE deals (both from foreign and domestic investors) when the supply of money in the economy is high, often controlled by the Reserve Bank of India. The investments are significantly high when the Rupee appreciates against US Dollar and when the industrial production increases.
However, foreign investors respond differently to interest rate environments. Domestic investments fall when the Bank ("discount") rate goes up whereas foreign investors that raise their capital outside of India are not sensitive. Domestic investments do not exhibit any significant association with the yield curve or increasing default risk in the debt market whereas foreign investors are quite sensitive to these indicators. Interestingly, foreign investments are higher when the yield curve is relatively flat, and the default spreads are high. In other words, while domestic investments are not sensitive to macroeconomic indicators of risk in the debt markets, foreign investors jump on deals when the market outlook points towards increased risk. A larger number of foreign deals during times of higher risk, perhaps, show an intensified pursuit for premium on returns.
Clearly, foreign and domestic investments are differently sensitive to macroeconomic fundamentals. We must not forget that all investors are sophisticated. So, the differing sensitivities to indicators portray differing standpoints to assess the market outlook. Such differences are well documented in academic research. Locals possess a great deal of "soft" information that is valuable, but often not available to foreign investors. Foreign investors are increasingly aware of this issue and find innovative ways to compensate for such informational disadvantage. Such innovations are rooted in unique sources and analysis of information. See the illustration, for example. Domestic investment trends are sticky, whereas foreign investments are spiky. In other words, foreign investors might be closely watching the flow of new information available to them, and dynamically responding to them.
While macroeconomic data is more readily available, the political environment is difficult to track. Yet, although stalwarts like Warren Buffet outrightly reject the idea, investors' sensitivity to prevalent political environment is a well-known determinant of investment.
In line with numerous applications of Google Trends in finance research, we found that direct PERE investment related searches are, indeed, significant predictors of PERE deals, both from domestic and global investors. Further, we wondered if the search trends could also be used to measure the political concerns of PERE investors. So, we developed a list of dominants political issues in India related to Caste, Religion, Employment, Terrorism, etc. and tracked investment-related Google searches on these topics.
We found that investors respond significantly to domestic political attention to socio-economic issues. More interestingly, foreign investments are more strongly associated with political search trends on Google than domestic investors.
One would wonder why foreign and domestic investors show such a stark difference in their association with political search trends. Whether the search trends themselves cause the deals is a questionable proposition. However, the Trends' underlying association with corresponding press coverage (domestic versus foreign) of Indian political issues is a more plausible explanation. It may also be reflective of how domestic and foreign media put differential stress on India's political issues.
Nevertheless, if predicting the investment deals is an objective, Google search Trends offer an effective tool.
(The authors are Associate Professors at Real Estate Finance at IIM Ahmedabad, and Real Estate at RICS School of Built Environment, Amity University, Noida respectively)