Foreign institutional investors (FIIs) are betting big on Indian markets despite all the challenges that the economy is grappling with. Consider this: FIIs have pumped in over $19 billion (Rs 99,000 crore) into the Indian equity market so far in 2012 compared with a net selling of about $500 million last year.
FIIs are buying at a time when the economy is slowing down rapidly and is expected to grow at just about 5.5-6% in the current fiscal year. The current account deficit and inflation continue to remain way above comfort levels and the government is likely to miss the deficit target on the fiscal front.
Though inflows have come in handy on the currency front, at another level, it poses a question: what this means for the Indian stock market and Indian investors? Will this trend continue? From the investment point of view, should you be investing in companies which FIIs are buying or already have a large holding in?
High FII inflow
Large FII investments in the current year have been coming on the back of net selling in 2011 due to rise in volatility and uncertainty in the global financial system, which resulted in the benchmark Sensex losing about a quarter of its value during the year.
However, as conditions improved, FIIs were back in action. Says Andrew Holland, chief executive officer, investment advisory, Ambit Capital: "The inflows are positive for the market and this goes on to prove the long-term potential of the Indian market despite all the negative talk domestically."
Apart from the long-term fundamentals, which are facing serious challenges due to macro headwinds, are there other factors responsible for the inflows? Says Daljeet Kohli, head of research, IndiaNivesh Securities Pvt Ltd: "It is the uncapped global liquidity which is resulting in risk taking, leading to inflows into the Indian market." Kohli highlights that inflows may not stop because of lack of liquidity in the global financial market, but funds may get diverted in case investors get a better option than India. For example, foreign investors may take a fresh look at the Chinese market because of clarity on change of guard on the political front in the country.
Do higher inflows always mean higher gains?
Stock prices depend on multiple factors and the participation of foreign investors is just one of them, though a dominant one. But higher inflows in absolute terms do not always lead to higher gains in the market.
For example, in 2010, FIIs pumped in at least $29 billion, the highest ever in a single year, but the markets measured by the benchmark BSE Sensex went up by only 17%. However, in 2009, with a net inflow of $17.6 billion from FIIs, markets shot up 81%, though the year was also marked as the recovery year from the fall of at least 50% in 2008. Thus, it is tough to say convincingly that higher FII inflows always lead to higher gains.
In fact, in 2000 and 2001, despite positive inflows from FIIs, markets lost ground. Interestingly, since 1993, on annual basis, FIIs were net sellers in the Indian markets only on three occasions and markets lost ground in these years. However, net buying has not always resulted in rising markets.
Should you chase stocks with high FII exposure?
From September 2011 to September 2012, FIIs increased exposure in 22 of 30 Sensex stocks. The average holding in the Sensex stocks has gone up from 19.59% to 21.09% in the period. Should you also invest in companies where FIIs are increasing their stakes or companies which have large FII stake?
There can be different opinions on this. Companies that have large FII holdings would naturally be large and liquid counters, which make entry and exit easier for large institutional investors and is a plus point. But it should not be the only investment criteria for retail investors. "You should not invest in stocks just because FII have invested. You should ask yourself why you want to buy a particular stock. FII holding in the company should not be the driving force," says Kohli.
Put differently, it is important to follow the basics of investing and not follow the bandwagon. Says Kishor P Ostwal, chairman and managing director, CNI Research Ltd: "Retail investors should not chase stocks with high FII holdings as these are generally large stocks that are fairly valued. Investors would be better off by looking at mid-cap ideas as there is still value available." Ostwal also highlights that once large institutional investors are done with large stocks from the valuations perspective, they also start focusing on mid-cap stocks.
Higher-than-expected FII inflow in the Indian market could well be a reflection of easy availability of money in the global financial system and FIIs could be betting on earnings revival and appreciation of currency. But investors should invest on the merit of the company and not on the ground that who else is investing.