FIIs call the shots in corrections

The three corrections in stock markets this year - February, August and now in October - has one common thread, which is the dominance of foreign investors/hedge funds in the equity markets.

Even if the FIIs sell stocks worth a mere $5 billion (which is relatively small, as their total holding amounts to $300 billion and the market capitalization of the domestic stock market is in excess of $1 trillion) within a short span of 4-10 days, this creates unhealthy nervousness in the market, according to market experts.

But except for the latest sell-off, which was triggered by a local event, the other two corrections were caused by global happenings such as the unwinding of yen carry trades by foreign investors in February and the US sub-prime crisis in August.

The Sensex shed 11.69 per cent, or 1,714 points, to 12,938 in February after hedge funds and other foreign investors reduced their "yen carry trades'' exposures in stock and commodity markets across the globe, including India.

Hedge funds mostly invest in Indian markets through the P-note, an offshore derivative instrument having Indian stocks as underlying and issued by FIIs to anonymous investors.

Yen carry traders, who accessed cheap funds from Japan were forced to unwind their exposure in global markets after Bank of Japan hiked its overnight loan rate to a 10-year high of 0.50 per cent on February 21, triggering a sell-off in most emerging markets.

As a result, the Sensex shaved off nearly 12 per cent from a high 14,652 on February 8 to 12,938 on February 28. During the US sub-prime turmoil in August, the Sensex shaved off nearly 9 per cent, or 1,318 points (from 15,308 on August 8 to 13,990 on August 21) after foreign investors fled riskier assets in emerging markets, including Indian stock markets.

"What we have seen in the first two instances is the withdrawal of leveraged funds (either hedge funds using leverage as a strategy, or hedge funds having leveraged funds from investors). So, it is ideal to say that global events are triggering panic-selling by leveraged investors. It is similar to redemption pressures faced by mutual funds from investors," said a CIO of a foreign mutual fund.

Last week's fall of 1,499 points, or 7.8 per cent (from 19,058.67 on October 15 to 17,559.98 on October 19), following Sebi's proposals to curb capital inflows through the PN route, was also triggered by a sell-off by hedge funds, who invest mostly through offshore derivative instruments.