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Raghuvir Srinivasan

The current calendar year is likely to be the best for inflows from foreign institutional investors ever since FIIs started investing in the Indian stock market in the early 1990s.

As of September 19, FIIs had invested $9.88 billion in the Indian market on a net basis (purchases minus sales) this year, very close to the record $10.7 billion they poured into the country in 2005. This is only their investment in the cash market, w ithout accounting for inflows into the derivatives market.

As early as the second week of July this year, FII investment in the cash market since January had crossed the $8 billion they had invested in India in the whole of 2006. This is a clear index of how bullish this category of investors is on the prospects for the Indian stock market.

In this backdrop, Business Line studied the trading pattern and behaviour of FIIs from May 2006 to now. The market witnessed three corrective phases in this period (including the almighty crash of May 2006) and followed it up each time with a remarkable recovery that took the indices to the next level.

What was the FII investment pattern in this period? Were they sellers during each of those crashes? Did they lead the recovery process each time with aggressive buying?

FIIs account for a little over a third of the total turnover on the BSE and NSE today. In the 17 months from May 2006 to now, FIIs have, on an average, accounted for 34 per cent of the total turnover on the two exchanges on a monthly basis.

In comparison, the next big category of investors, mutual funds, account for just under 10 per cent, on an average, of the market turnover.

Interestingly, during the three corrective phases in May-June 2006, February-March 2007 and August 2007, the FIIs’ share of trading volumes soared well above the average. In June 2006, when the Sensex touched a low of 8,900 points, FIIs accounted for 41 per cent of the total turnover on the two exchanges, selling almost as much as they bought. They made net purchases to the extent of Rs 480 crore that month — well below their average monthly net investment of about Rs 3,400 crore (between May 2006 and now).

The FIIs were aggressive sellers in that period alright but what also contributed to their higher share of turnover was that the other categories of investors, such as mutual funds and retail investors, stayed away from the market.

The story was similar in February and March this year, as also last month, when the Sensex went through a minor correction phase. The numbers prove that FIIs do book profits at every correction; an alternative view could be that FIIs were responsible for each of those corrections. Given that there is no other single organised category of investors to match the FII might, the second view seems more acceptable.

If they were at the vanguard of the selling brigade during the troubles, FIIs were certainly not driving the rally that took the market from sub-9000 levels in June 2006 back to 12,000 last September. The share of FIIs in total turnover on the two exchanges, at 26 per cent and 27 per cent in August and September 2006 respectively, was well below the average of 34 per cent.

Interestingly, they were net investors of well over a billion dollars in each of those months but their gross purchases and sales were significantly lower than average. In other words, they were circumspect and not willing to jump in with enthusiasm. Their view, however, changed once the market regained its peak in September 2006; their gross purchases rising significantly after that.

The story was, however, again different in the period following the February-March correction this year, as also the one last month.

This period saw FIIs invest aggressively. For instance, April saw them invest about Rs 6,700 crore on a net basis while in the first three weeks of this month they have already invested a whopping Rs 8,900 crore. Their net investment of Rs 2,485 crore on a single day — September 19 — is higher than the quantum they invested in the whole of June.

In the 17 months since May 2006, FIIs were net sellers only in four — May and December 2006, and March and August 2007. Interestingly, except December 2006, the other three were all during market corrections.

The analysis throws up an important question on whether the present disclosure of information on trading by various market participants is adequate. FIIs, it is found, account for about a third of the total turnover in the market while domestic mutual funds account for about 10 per cent. That adds up to less than half of the total turnover. Who then accounts for the remaining half, or more?

Our Going by data put out by the BSE, the category called “clients” accounts for 35-40 per cent of turnover, on an average.

A further break-up of this category into retail investors and HNIs (high-net-worth individuals) appears necessary, considering that the category accounts for such a large block of trading volumes. At present, the BSE puts out a broad break-up of category-wise turnover between FIIs, domestic institutions, clients, NRIs and proprietary trades of its members.

The NSE, on the other hand, discloses turnover information in four categories of banks, financial institutions, proprietary trades and “others”. The last-mentioned usually accounts for the largest chunk of turnover and includes client trades.

Again, with the increasing investment by private equity firms in Indian companies, it must also be examined whether their equity holding needs to be disclosed separately. As of now, the shareholding pattern of companies as disclosed to the exchanges seems to classify private equity firms under FIIs though there is a separate category called “venture capital firms”.

Take for example, Baroda Rayons, a sick company whose stock is not traded. However, a private equity firm Clear Water Capital Partners Cyprus Ltd. has bought 38.56 per cent stake in the company. The BSE filing of the company shows the investment under the FII category. How is an FII investment possible when the stock is not traded?

The investment philosophies of private equity firms and FIIs are radically different and need to be treated as such in market filings. It will certainly help if the regulator, SEBI, looks into these aspects of disclosure, especially of daily turnover, and defines the categories in a sharper manner.

SEBI could consider disseminating such well-defined category-wise turnover details of all exchanges put together just as it now discloses FII and MF investments.

Clearly-defined categories and information for the entire market being made available in a single place will help shed more light on the forces driving the market.

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