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Suresh Krishnamurthy

BILLIONS of dollars have poured into Indian stocks from foreign institutional investors (FIIs). Unerringly, these have found their way into the larger of the large-cap stocks.

Whatever may be the reason behind this strategy, it does appear as if FIIs are entering the battle with one arm tied behind their backs.

Needless to say, this approach could spell a spectacular opportunity for Indian investors. They can make money by investing in mid-cap stocks and gain even more when the stock's market capitalisation rises, as only then will the FIIs enter the counter.

Given that there is enough scope for FIIs to increase their interest in India, this strategy could continue to rain returns for investors.

Large-cap penchant: The value of FII holdings at the end of March 2005 totalled about Rs 2,20,000 crore — up from Rs 43,000 crore at the end of March 2003.

The rise in value, however, is almost singularly explained by their investment in large-cap stocks.

Investments in large-cap stocks — stocks with market-cap of more than Rs 10,000 crore — accounted for 73 per cent of the value of FII holdings at the end of March 2005, compared to 44 per cent at the end of March 2003.

In a way, the increase is understandable. The number of overseas investors entering India has increased significantly over the past two years. Given the size of their portfolios — the smallest of them would be several times larger than any Indian mutual fund scheme — only an investment in a large-cap stock could provide them at least a small stake in Indian companies.

Besides, less aware about Indian companies, these new tourists tend to visit the same set of large-cap stocks made popular by earlier visitors.

This phenomenon is likely to continue. One, overseas investors still do not hold a large proportion of Indian stocks. They hold nearly 15 per cent of stocks with market-cap in excess of Rs 5,000 crore.

Even if they are interested only in this set of stocks, there is enough scope to increase their stake in this set of companies to higher levels.

There are also a number of overseas investors who have still not invested in India. Spurred by the success enjoyed by investors in India and the higher standard of corporate governance than other emerging markets, these investors, too, are likely to pursue Indian opportunities in the next few years.

A rise in stake of FIIs by about 10 percentage points would need additional investment of about $25 billion. Notwithstanding the increase in the size of the market, this level of inflow would create ripples in the market. Even if this volume of investments comes into India over a period of three years, there would be considerable impact on stock prices.

Riding the wave: A number of trends in the Indian market could be tied to the FII fund inflows and their peculiar investment strategies. Most important of them would be:

Out-performance of Nifty Junior

November effect

The Nifty Junior is the place for mid-cap stocks aspiring to become large-cap stocks.

These stocks are generally bigger than many of the mid-cap stocks but still cannot be considered large-caps. They are the set of stocks that FIIs would be attracted to. As money pours into such stocks, Nifty Junior consistently outperforms other indices.

Another factor is the November effect. In eight of the past ten years and for five consecutive years, stocks have risen in value between November and February — months in which FII interest has peaked.

These two trends could persist, as FIIs' affair with large-caps continues.

This offers investors an opportunity to make money in the process. In the past, mutual funds have taken advantage of this trend and notched up attractive returns. High net worth investors, too, would have cashed in. If you haven't yet, your turn might be just round the corner.

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