The domination of FIIs

S. Vaidya Nathan

AS 2001 draws to a close with about six weeks of trading left, the big story on the market has, undoubtedly, been the increasing domineering role played by the foreign institutional investors.

The FIIs have been at the forefront for some four years now. But at no time in the past were the domestic mutual funds and investment institutions rendered insignificant as they in 2001. Sample some of the key numbers:

FII purchases in 2001 to date have been Rs 51,253.7 crore and selling, Rs 38,182 crore. Together, they make up around Rs 90,000 crore by way of secondary market action. The FIIs have been net buyers in 2001 to the extent of $2.8 billion closing in on the 1996 record of $3.06 billion.

In sharp contrast, for 2000 and 2001 together, mutual funds purchased shares worth Rs 33,391 crore and sales Rs 39,501 crore. Mutual funds were net sellers for much of the 23 months in 2000 and 2001. Mutual fund secondary market data have been available regularly from 2000 only.

For the two-year period (2000 and 2001), the FIIs aggregate trading activity is Rs 2,32,882.8 crore while that of mutual funds has been Rs 73,495.4 crore. These numbers clearly provide a perspective on the big gulf that has emerged between the FIIs and domestic institutional investors. Throw in the speculative trading that goes on, the share of domestic institutional investors would become a much smaller fraction. In 1999 and parts of 2000, the gap was not as pronounced, as domestic mutual funds had inflows and were big investors.

With inflows into equity funds virtually drying up and the funds facing redemption pressures, mutual funds were net sellers in a steadily declining market in the last 18 months or so. The FIIs were net buyers in this period. In terms of a signalling effect, the FIIs have led the market ever since their scale of operations expanded and the bull market of 1994-95 ended. That was the case when their trading levels were of a lower magnitude than has been the case in the last three years. Now the FIIs have big volumes in their operations as well. In fact, 2001 is, probably, the first year of a bearish market where FIIs have been big traders.

The sheer quantum of buying and selling has made it more difficult to determine the direction of FII flows. This was much easier in 1996-1998. In this backdrop, what do these trends mean for investors, in general, and those in mutual funds, in particular:

Quite clearly, for domestic mutual funds without a FII linkage, there could be a problem as they could well get submerged in the activism of FIIs. The problem could get acute if they decide to adopt a follow the FIIs route as they may then enter and exit stocks at sub-optimal prices

There is also no evidence of a fund without a FII linkage doing well either by cloning the FIIs or by taking a contrarian position. At the same time, the fact that quite a few funds with FII linkages have had a disastrous last 18 months must be a part of the investment decision process.

For one domestic fund, though, these developments may be positive -- the Unit Trust of India, in contrast to much of the past decade, when it had to bear the cross for being a major player. Now its buying and selling decisions may be a small fraction in the market, which could work to its advantage. The fact that the FIIs collectively hold almost twice the equity held by UTI, and the fact that they trade much more actively than the UTI ever does, indicates the better balance in the market place.

Is the fact that FIIs are dominant, a good reason to associate with FII sponsored funds? For the sheer lack of choice, the answer has to be `yes'. But when it comes to buying and selling decisions, it is quite likely that the FIIs would give first preference to the global portfolio and then come to the domestic fund's position.

In the best-case scenario (which may not happen due to the signalling effect), the actions on the global and domestic portfolio may take place at the same time. Despite this, if the FII-sponsored funds are better options, the only supporting reason is that they may be still ahead of other funds in terms of investment decisions. They may closely follow the FII decision and action on the global portfolio.

There is, however, the question of which FII-linked fund to choose. Based on performance over the last three-five years, especially last year, funds such as Zurich India, Pioneer ITI, Alliance Capital and Templeton, seem to the ones to go along with. But this is to be constantly evaluated depending on performance of schemes.