FIIs Are Back!

The trend, at least in the near term, seems to have reversed for the markets. While the headwinds remain, the cooling of the commodity prices, especially the crude oil prices are boosting the chances of a sustainable rally in the equity markets. FIIs have long been considered as one of the most important market participants in India and they have started buying into the equity markets in India after an aggressive consistent selling in 2022. Yogesh Supekar discusses the market trends with reference to the FII turning net buyers
 

The year 2022 has been a volatile year so far. After a more than 21 per cent rally in the BSE Sensex in CY 2021 it was expected that some sort of consolidation may happen in the market. However, the real trigger happened in the form of a geopolitical situation that we are still dealing with in the form of the Ukraine – Russia war. The war led to unprecedented disruption in the supply chain globally, similar to the situation faced by the global economy during the peak of the pandemic. This supply chain disruption led to volatile spikes in the commodity prices due to which the inflation figures soared. 
 

The unexpected rise in inflation led to US Federal Reserve and global central banks to take remedial action by raising interest rates. Such earlier-than-expected increase in interest rates created a negative sentiment amongst the global investors. Whenever a global situation happens that has the potential to impact the global economies negatively, the tendency of investors is to remove money from supposedly risky assets and park the funds in the safe havens. Traditionally, equity is termed as a risky asset while gold and fixed income securities can be considered as less risky assets.
 

When any geopolitical situation arises it is normal for global investors to withdraw money from the emerging markets and park the investment proceeds into what may be considered relatively less volatile. Now, when we consider the investments of the FIIs in India, there are essentially two types of risks undertaken by the investors – currency risk and market risk. Thus, investing in emerging markets like India becomes an extremely volatile proposition for the FIIs when we consider the currency volatility as well. 

If we look at tables below, we get a fair idea of how heavy the selling has been in India by the FIIs:

Stocks with FII Exposure

There is a school of thought that suggests ‘buying stocks’ where FIIs have already bought shares. The common perception is that the stocks where FIIs are bullish are the ones that may outperform the markets and hence it is better to include such stocks in the portfolio for outperformance. Then there is also a counter-argument which says that FII money is hot money and tends to be very nimble. An investor may buy a particular stock looking at the FII purchase data and by the time he finishes the buying the FIIs may turn net sellers, thus pulling the stock prices down by a good margin even when the fundamentals of the stock are intact. Thus, owning a stock where FIIs have in a heavy position can prove to be double-edged sword. Indeed, this is what we saw at the beginning of 2022 when FIIs turned net sellers. Those stocks where FIIs bought heavily were the ones that got hammered the most. Come August, it is the same stocks where FIIs were selling relentlessly which are seen outperforming as FIIs turn net buyers. 

INTERVIEW 

Mitul Shah
Head of Research, Reliance Securities 

FIIs are seen buying into the Indian markets. What are they buying?

FIIs turned buyers in July 2022 to the tune of ~Rs 50 billion after nine consecutive months of selling of Rs 2,559 billion since Oct 2021. FIIs buying is seen in sectors like FMCG, power, healthcare, capital goods and BFSI, while they sold in oil and gas, IT, telecom and automotive. We expect FIIs to remain net buyers as the valuations are reasonable comparatively while India is expected grow faster compared to most other emerging nations. 

Why is FII participation important according to you?

FII inflows are of prime importance as they have played a significant role in the capital market since decades. The inflow also supports currency and in turn the economy as stable exchange rate is very important for any economy to record decent growth. FII buying not only supports the market and stock prices but it also increases the confidence of domestic investors as well as strengthens the positive view on markets for all investors. 

What is your message to investors who follow stocks where FIls are investing?

The investor should consider companies with high growth potential, stable margin, cash flow, higher asset utilisation, return ratios and a decent capital structure within the universe of FII holdings. Investors should give clear focus on valuation apart from all the above factors as it is the most important parameter to consider for any investment. In the past there have been instances that FII buying lifted the valuation while it hasn’t delivered good return post that due to valuations. Therefore, one should not get carried away with FII holdings while ignoring valuations.

What is the outlook on Indian markets?

The market recovered in July 2022 with 9 per cent gain, led by softening commodity prices and strong earnings’ session. The RBI is expected to raise interest rates again by 35-50 bps in the August MPC meeting. The healthy earnings’ session is expected to continue next week as well which is likely to mitigate the negative effects of the rate hike in the coming week. Commodity prices have started softening and overall retail inflation is being mitigated. However, food inflation is still a major concern due to the sporadic and unequal monsoons. The Russia-Ukraine war and concerns of the return of the pandemic continue to play a key role in affecting global markets.
 

Though near-term negatives in terms of concerns of depreciating rupee, widening trade deficit, FII selling and volatility in global crude prices continue to exert pressure on the economy and equity markets, we expect strong economic rebound, normalised commodity prices, inflation within a targeted range and better visibility in 2HFY23E. This would lead to strong rebound of the equity market and FII inflow towards the end of 2QFY23E and beginning of 2HFY23E. We remain positive on Indian equity and maintain our FY23-end Nifty target of 19,000.
 

Correlating FII participation and stocks prices is more complicated than one may assume it to be. However, healthy and consistent FII buying can push the market higher. Positive correlation between FII being net buyers and market delivering positive returns can be seen on numerous occasions, as for example, in 2020, 2019, 2014, etc. Says Jitendra Bihani, a long-term investor: “I have some filters that I use to select high-quality stocks. Apart from the fundamental and technical parameters that I study for picking portfolio stocks, one of the most important parameters that I always follow is institutional holdings.”
 

“If a stock that I want to include in my portfolio is already bought by a mutual fund or by a FII it means that smart money is already invested in the stock. This helps me in building conviction in the stocks that I wish to pick for my portfolio. I usually use this filter when I want to allocate a sizeable portion of my portfolio to a particular stock. There are times when I try to outsmart other investors by entering stocks before the smart money buys them i.e. I attempt to pick illiquid micro-caps before the extraordinary growth story attempts to catch institutional investors’ attention. However, it is extremely risky do to do, and my success ratio is not very good when I attempt to enter early i.e. before the smart money,” he adds.
 

“The thing with stocks that are held by FIIs and DIIs is that they are extremely liquid and can be churned anytime. The slippages are also very low in stocks that are institutionally owned, and the information is widely available in the public domain about such stocks which makes it comforting for an investor like me who believes in maximising risk-adjusted returns. That said, I do not buy any stock just because the FIIs have bought them. FII increasing their stake and DIIs also buying in a particular share is just one of the several positive factors along with other fundamental and technical factors I usually give weightage to,” he further states. 

Siddhartha Bhaiyaa, Managing Director and Fund Manager, Aequitas Consultancy Pvt. Ltd. 

It is said whenever the FIIs sneeze, the Indian markets catch a cold. Their buying action is one that almost always has propped up the markets and conversely whenever they have sold, investors have been left licking their wounds. To give an instance, in 2008 the FIIs sold approximately USD 8 billion worth of stocks and the markets fell by nearly 50 per cent. We have done an internal study that over 20 years starting from January 2000, whenever FIIs have been negative on India on a monthly basis, the markets have delivered a negative return 88 per cent of the times and whenever there have been positive inflows, 74 per cent of the times the markets have given a positive monthly return.
 

And in this phase of 20+ years we have seen the FIIs increasing their share of the free float to a maximum of nearly 65 per cent in 2014. However, it would be remiss if we were not to add that the massive sell-off that happened between October 2021 and June 2022 where the FIIs cumulatively withdrew approximately USD 30.5 billion (Rs 2.46 lakh crore) has made the markets correct by only 15 per cent. In this sell-off another interesting observation has been that the Indian retail segment for the first time has overtaken the FIIs in their percentage holdings.
 

In the month of July, on the other hand, over just the last nine days FIIs bought approximately Rs 5,000 crore of equities, which resulted in the markets rallying and giving their best returns since March 2020 at 10 per cent. Given the above correlation, FIIs are clearly a very important participant of the Indian markets.
 

The overall effect that FIIs have had on the Indian markets in terms of the valuations of the Indian markets is as follows: Total FII investments in India are approximately USD 650 billion or a third of the Indian market capitalisation. This huge inflow ensures that the markets are buoyant and valued at a premium over other similar markets. In the derivatives segment FIIs provide liquidity by almost always being the only ones on the other side of the trade. As regards global standing, the Indian bourses have also improved in part due to FII participation as we have kept up with the best practices internationally, including 100 per cent demat accounts and the T+1 settlement. 

Conclusion

Gone are the days when we could say that the development of the Indian equity market is perpetually linked to FIIs’ participation. FIIs were dominant players before the pandemic hit us and FIIs continue to remain one of the most important market participants. However, no more is the Indian equity market at the mercy of FII flows if we go by the rising participation of the domestic investors. The most ideal situation for the equity markets or for the bulls is healthy and consistent inflows from both the DIIs and the FIIs. After all, fundamentals without the support of money flow will not take the stock prices higher.
 

There is ample data to suggest that the markets tend to deliver positive returns in the period where FIIs participation is high. After being net sellers since the beginning of CY 2022, FIIs have turned net buyers since the second half of J uly this year. Since July 15, the BSE Sensex is higher by more than 9 per cent with several stocks clocking higher double-digit returns. FII participation in July is proving to be a turning point for the markets, at least in the short run. The outlook on market is turning bullish despite the clear headwinds for the markets. It is the positive earnings’ report and the signs of inflation peaking out even as commodity prices cool down a little that is boosting the market sentiment. Improving supply chain issues is helping curb the volatility in commodity prices.
 

The Indian economy continues to be the fastest growing economy amongst the large economies. There is a definite boom happening in the manufacturing sector in India and some of the manufacturing activity is already shifting to India as we speak. FIIs are seen buying into interest ratesensitive sectors such as financials and automotive. FIIs were seen buying into cyclicals and FMCG as well, while reducing stakes in IT and metals. Some buying was seen in the construction and cement space as well by the FIIs after relentless selling that started in October 2021. Some buying in real estate stocks is also seen after consecutive months’ selling pressure. FIIs have reduced their stakes in pharmaceutical stocks in 2022.
 

Clearly enough, the Indian equity market has managed to outperform not only the emerging market peers but remains one of the most resilient markets globally in 2022. With inflows reversing since the second half of July and DIIs buying, we can say that good days are ahead of us. There will be some volatility as the market has run up by almost 15 per cent since mid-June when the recent bottom was made for the markets. Investors can continue to build their portfolio as the FIIs have turned bullish on the Indian market after a long time!