A simple twist of fate

SPECIAL REPORT

Mutual funds continue to invest in the market, while FIIs seem to be booking some profits.

Till April this year, FII inflows have had a direct correlation with the price-levels in the Indian stock markets for the last ten months. When they were net buyers, the index gained, and when they sold, the index fell.

But in the past ten-odd trading sessions, investors seem to be increasingly banking on the mutual funds to save them from any melt-down as the markets have remained firm in spite of considerable FII outflows.

According to the Securities and Exchange Board of India (SEBI), except for October, foreign institutional investors (FIIs) have not been net sellers of Indian equity in the last ten months ending March 2006. Altogether, they pumped in Rs 50,192 crore into the Indian equity markets during the ten months from June last year to March this year.

In this period, the equivalent contribution by Indian mutual funds was slightly over a fifth of that, at Rs 10,750 crore. During the same ten months, the Sensex has put on more than 67 per cent, rising from around 6,700 points at the beginning of June 2005 to almost 11,300 at the end of March 2006.

October, the only month in between, when foreign funds were net sellers, saw the index slide more than 12 per cent, despite the fact that Indian fund-buying to the extent of nearly Rs 2,900 crore did substitute to some extent for the Rs 3,800 crore sell-off.

Now, according to the same figures, FIIs have cut their exposure to the Indian spot market by nearly Rs 1,600 crore in April 2006 alone, with most of the sell-off happening over the last seven trading days which saw an outflow of more than Rs 2,500 crore.

The figures are nastier on the Exchanges according to whom there was a net outflow of more than Rs 3,600 crore this month, including the Rs 122 crore pulled out on the last day of trading on Friday.

While earlier such an FII sell-off would have been unthinkable without a hysteric reaction from the markets, this time, instead of being beaten down, investors, intoxicated by better-than-expected corporate results, took the Sensex to uncharted territories.

The Senses hit a life-time high of 12,102 on Friday. No thanks to the FIIs, the index is still higher by 280 points than the closing level on the day before FIIs started selling.

An analysis of the fund flows shows that the current levels are maintained by a peculiar mix of retail investor optimism and a dash of desperation on the part of Indian mutual funds.

For example, as soon as news of large-scale FII sell-off spread in the market exactly two weeks ago, on April 7, the smaller investors too reacted, setting off a panic selling that saw the index fall from a high of 11,930 to 11,589, a drop of nearly 341 points in just a few hours with rumours of SEBI banning some FIIs.

The next day, the market was up by nearly 80 points, reassured that the rumours were unfounded. However, with news of continued FII-sell-off the market too seems to have lost its nerve and went into the panic mode over the next two days, losing nearly 650 points to touch an intra-day low of 11,008 on April 13. What happened since seemed to have set the mode for the current behaviour of individual investors.

Having waited patiently for nearly three months since December, and even booking some profits, the Indian mutual funds seized upon the 650-point dip as a god-sent opportunity to get back into what seemed like a market that not only refused to correct, but to their dismay, kept going up, raising their "opportunity cost".

On April 13, the day the market touched 11,008, Indian mutual funds invested nearly Rs 521 crore"�the highest single-day investment by domestic funds since October 19, 2005.

While the markets immediately bounced back nearly 230 points, the purchases also seemed to have altered individual investors' perception of the market as proved by the subsequent bull-run of nearly 1,200 points which paused only last Friday.

Small investors are also not ignorant of the fact that, thanks to record new fund collections in the last three months estimated at nearly Rs 20,000 crore, Indian funds still have a surplus of nearly Rs 10,000 crore which they need to invest over the next four months.

As a result, immediately after the rapid slide was halted by the Rs 521-crore purchases on April 13, small investors shrugged off all the subsequent minor FII sell-offs in the next two sessions and took the Sensex on a 500-point rally which ended with the Sensex coming back to its pre-correction level at 11,820 by Tuesday last week.

Having once tasted blood, retail investors again took the index up another 220 points over the remainder of the week, though only around Rs 230 crore was put in by domestic funds and FIIs sold nearly Rs 122 crore on the final day of the week.

As of now, the three main players in the market seem to be in three different frames of mind. Reassured that mutual funds will prevent any major back-slide and encouraged by positive results from companies, a mood of bullish aggression seems to have gripped retail investors.

However, for a change, sober notes are coming from the FII panel, usually the most aggressive participant. Besides having cut positions in the cash market, FIIs have also reduced their exposure to the futures market by nearly Rs 5,350 crore since the beginning of this month, while at the same time, they have hedged their positions by pouring nearly Rs 800 crore in the options market.

The third player, mutual funds, seem to caught in the middle, between belligerent retail investors and disapproving FIIs. Though equally disapproving of the current levels at which many of their stock picks seem hung too high, fund managers are at the same time not ready to repeat the mistake they made three months ago by sitting on the sidelines of a galloping market.

How much higher will the retail investors take the market, whether FIIs and Indian funds will join the party again and whether the funds will step in to save the day in case of a correction are questions that are likely to be answered this week.