First-time investor Sharad Gagdani is a happy man. He put Rs 2 lakh in the stock market four months ago. With the Bombay Stock Exchange (BSE) Sensex recently crossing 20,000 for the first time in two years, his portfolio is already up 10 to 15 per cent. His advisors are urging him to book profits, but 28-year-old Gagdani, who runs an artificial jewellery business in Mumbai, is sitting tight. He isn't investing any more money in the market but says: "I will wait before I book profits."

K.R. Bharat, Managing Director of Advent Advisory Services, is also guarded, though his optimism is a contrast to his mood four months ago. He has reduced his cash position from 50 to 20 per cent, although he says nothing has changed structurally in India. "I still remain negative on fundamentals," he says. "It would be foolish to think beyond two or three months."

Further along the optimism scale is Gary Dugan, Chief Investment Officer for Asia and the Middle East in RBS's wealth division. He is investing 25 per cent of his personal incremental money - some 10 per cent of its portfolio - in Indian equities. India accounts for four to five per cent of his total allocation. He says: "India is a clear standout. There are very few markets in the world which would deliver a return on equity of above 20 per cent." This year, he says, he sees the Sensex going up to 24,000. "The Indian government has at least shown seriousness to act on its reform process, while others are still struggling to sort out their internal problems," says Dugan of RBS.

Perhaps this is why the rise of India's stock markets continues to be an FII story. With the government perceived as being intent on reforms, negatives being factored into stock prices and the sustained inflow of money, the Indian equity market looks set to rise for the second year in a row. FIIs, or foreign institutional investors, have been the backbone of the Indian market and, for the past few years, the biggest reason for buoyancy.

FII investments matter because they influence sentiment across the board. In the past 13 months, FIIs infused more than $26 billion (about Rs 1.41 trillion; a trillion equals 100,000 crore) into the Indian equity market, helping the Sensex gain 30 per cent from 15,454.9 on December 30, 2011, to 20,101.82 on January 21, 2013.

If it were not for FII buying, selling by domestic institutional investors (DIIs) could have dragged the Sensex lower. According to National Stock Exchange (NSE) data, since January 2012, DIIs have sold equities worth Rs 67,020 crore.

So why are FIIs investing in India? In part because funds are available cheaply around the world, and the US Federal Reserve is unlikely to touch interest rates until the end of 2014. The math is simple: borrow at nearly zero per cent and invest in India, where interest rates are eight to ten per cent. Abhay Laijawala, Managing Director and research head at Deutsche Equities, says: "India is one of the strongest safe havens in the world. For a pension fund that is seeking eight per cent returns for its clients, India is one of the best options and therefore we are seeing sustained flows from FIIs into Indian equities."

"The money is coming from all quarters of the world, as every country in the West is printing notes," says Advent's Bharat. RBS's Dugan concurs: "In a scenario where countries like Indonesia are set to tighten rates, no one wanting to touch markets like Russia and China though attractive, still struggling, you have a country where there is prospect for further reforms, a central bank set to ease interest rates, and the expectation of a modest appreciation of the rupee. These all augur well for Indian equity market and therefore money is flowing into India."

He adds that investors don't mind investing in India although its growth is weak, because they realise that if reforms are back, they will trigger long-term growth. "Never before have we seen such eagerness in the government to embrace reforms, cut expenses and increase revenues, though it has to be seen if they bite the bullet," says Laijawala. "The recent hike in diesel price will start building that faith," says Laijawala. He says that even if the reform process comes to a standstill, the flows may slow down but won't dry up.

The reason why the money will not stop is reallocation to equities from bonds. "Investors shunned equities after the global financial crisis, with money getting into bonds," says Rashesh Shah, Chairman, Edelweiss Group, a Mumbai-based financial services firm. Globally, as bond valuations reach extreme levels, investors risk losing money. FIIs casting about for alternatives are drawn to countries which can deliver returns - such as India.

Credit Suisse's Head Equity Strategist for Asia and global emerging markets, Sakthi Siva, says: "China and India are the markets that offer the most upside, as there are huge gaps between Index and EPS, and equities will have to catch up with earnings.

The MSCI India Index is currently trading 45 per cent below its EPS, unlike in 2007, where it was trading 44 per cent above the EPS." She is referring to the Morgan Stanley Capital International India Index, which designed to measure the country's equity market performnce. EPS, or earnings per share, in this case refers to the companies included in the index, much as the Sensex has an EPS.

"There is clear polarisation between FIIs and domestic institutions," says Nilesh Shah, Director at retail broking and financial services firm Axis Direct. "FIIs are finding the Indian market better than their own peer market. For them, 5.5 per cent GDP growth is huge compared to a negative growth in their country. FIIs are taking a long-term view rather than one year, while our domestic institutions have been backward looking and are myopic."

He acknowledges, however, that with the Sensex rising, mutual funds face redemption pressure from investors, as they have not made money in the past few years. He points out that Indian investors tend to be less nimble then FIIs in turning bullish or bearish.

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