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Retail investors must pre-empt FII inflow & act accordingly

This article was posted on Jun 29, 2009 and is filed under Market News

Talk about the Indian equity market and the discussion invariably shifts to foreign institutional investors (FIIs). And their mention is not
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without merit. Over the years, FIIs have become a big force on Dalal Street and had a big role to play in the 5-year long bull-run that ended in January 2008. Their importance was even more pronounced in the ensuing bear-run as they led the sell-off on the street.

Their influence can be gauged from the fact that the value of FII holdings in the BSE-500 companies is equivalent to 12% of the combined market capitalisation of the index and they are one of the biggest non-promoter groups on the Street. The FII holdings in key large counters are even higher. For instance, the average FII holdings in Nifty 50 companies are nearly 15% of the total paid-up capital. All the above figures are based on the company’s shareholding pattern as on March 31, 2009.

Given their purchasing power, it’s but natural for FIIs to play a key role in the market movements. The adjoining charts show relative movement in FII investments in equities (on cumulative

basis) and NSE Nifty Index for the last ten years. As is evident, the Nifty closely follows the trajectory of FII inflows into the country. The correlation has actually become more pronounced from 2003, which coincides with the beginning of the big bull-run .

As readers will notice during the bull-run , every big move in FII investment (either positive or negative) was followed by a similar change in the Nifty. This aspect becomes clearer in the second adjoining chart, where we have plotted the monthly percentage change in Nifty against similar changes in the cumulative FII investment into the country. This foreign connection was in full force during the recent volatility in the benchmark indices.

In the past two weeks, the benchmark Nifty lost nearly 10%. This was blamed on the dwindling dollar inflows into Indian equity markets. In the last eight trading sessions, FIIs have been net sellers to the tune of over half a billion dollars. This sent shivers through the bones of bulls, many of whom fear that this may be a precursor to a big FII sell-off on the street. Given the recent FII activity, the fear is not without merit. The Friday rally would have, however, soothed many a nerves on the street.

The readers would thus be better served tracking the FII money inflows into the market rather than chasing dozens of other “leading” indicators. However, this is easier said than done. As the adjoining charts show, the FII investments are as volatile as the stock market itself. For instance, in the last 76 months, while average FIIs inflows have been to the order of $ 636 million, the monthly flows have ranged from a high of nearly $5700 million worth of inflows to outflows of $3100 million.

While such wild fluctuations make future estimates a tough exercise, we can make some sense out of the long-term trend in FII inflows into
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India. First, barring the blip in 2008, FIIs have always ended the year in a green zone. This has meant that Indian equity markets have always been bullish in the long term.

So if we average out the short-term fluctuations, long-term investors can expect a positive return from Indian equities. For instance, even during the lowest point in 2008, the Nifty was up nearly double its value from the peak of dotcom boom. Secondly, the FII investments never follow a one-way trajectory.

Every big purchase is followed by equally big sell-offs . There’s never a dull moment for an FII watcher. As the adjoining chart shows, dollar inflows take a roller-coaster ride and few months of positive inflows are followed by months when they are net sellers. The lesson for the retail investors is clear.

Never try to chase or mirror dollar inflows on the street, but rather pre-empt them and act accordingly. To put it simply, start accumulating when FIIs are relatively inactive (i.e market is looking dull) and begin booking profits just as the FII investment cycle is peaking (or the market is making new highs). For instance, in the latest rally, the FII investment peaked in early June and that was the time for retail investors to start booking profits.

If the past is any guide, every 4-5 months of positive FIIs inflows is followed by 2-3 months of negative inflows. And the wave length is getting shorter and the frequency is rising. For instance , between 2004 and 2004, the FIIs were net buyers for 19 consecutive months; next year the green patch never lasted more than 6 months and from middle of 2007, the buy and sell cycle alternated every 2-3 months.

The current buy-cycle is now 3 months old and FIIs may hit the sell button anytime now. Since early March, most large cap stocks have doubled while many mid-cap and small-cap counters have tripled. This is the kind of buoyancy that FIIs will love to book profits on.

The same rule applies to those of you who were smart enough to invest during the down cycle. It is time to book some profits so that when the FIIs press the sell button, you have ready cash to take advantage of the opportunity. As the saying goes, don’t try to catch the peak/bottom, ride the trend.

source: Economictimes

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