Investment options for FIIs are limited by the sheer depth of their pockets. They see no point in tiny positions in small-caps .
The year has been characterised by a dichotomy in institutional attitudes and September saw the contrast become stronger. Foreign institutional investors (FIIs) pumped in Rs 23,500 crore of net buying while the domestic institutional investors (DIIs) sold a net Rs 13,000-plus crore. Domestic retail players and operators have also been net sellers, making up the difference by FII buys and DII sales.
DIIs had been moderately net positive between January-August 2010 before they did this about-turn. The FII buying pattern accelerated sharply. The FII bought about Rs 19,500 crore net between January-August 2010 and more than doubled their 2010 exposure in a single month.
In fundamental terms, the DII attitude seems more rational. The Indian market is over-valued by its own historical benchmarks. At the net level, Q1 results were nothing special due to the impact of rising interest costs and the same adverse effects will be felt through the rest of the fiscal as well. So, even optimists will find it difficult to justify the Nifty ruling at 25 price-to-earnings (PE) multiple.
However, the FIIs have far more money than the DIIs. As a result, their perceptions, wrong or right, have more impact on the market. If the FIIs continue buying, it is possible, even likely, that they will push the indices up to even higher levels. Even if this is fundamentally unjustified, the Indian investor has little option but to go along.
This creates a “guess the beauty contest winner” situation for Indian investors, to borrow Keyne’s analogy. The great economist-cum-investor once compared investing to guessing the winners of beauty contests. In order to do that, you don't pick the women you consider most attractive, instead you pick the ones you think the judges will consider most beautiful.
The Indian investor must therefore, try to guess what the FIIs will do, rather than focus on fundamental valuations. Which specific stocks and sectors the FIIs will focus upon, assuming they continue buying?
My personal belief is that the FIIs will probably be net buyers for the rest of the year. There are no apparent news-based shocks in store for the Indian market, and barring natural disasters or terrorist outrages, growth in the Indian economy and the stock market will stay close to predicted rates.
On the global front as well, we’re seeing a gradual, incremental recovery. Again barring disasters, the FIIs have little reason to change their minds right now. In past experience, the last quarter (October-December) FII trade trends have usually been similar to the first nine months of the year.
The investment choices for FII are restricted by the sheer depth of their pockets. There is little point in taking tiny positions in small-caps because those cannot absorb significant investments. They are therefore, likely to continue pushing money into the top 100 stocks. This means the Nifty and the Nifty Junior universe will be accurate reflections of FII buying patterns.
It could also mean a gradual disconnect between big stock and small stock performance. That’s already evident. In calendar 2010, the Nifty is up 15.3 per cent while the S&P 500 is up 12.7 per cent. In September, the Nifty rose 10.2 per cent while the S&P 500 rose 6.9 per cent.
Apart from considerations of size, FIIs seem to like stories that they can relate to, rather than making their decisions on the basis of pure financials. They will buy commodity stocks like metal producers because the China story looks good with respect to that sector. They like IT-ITES businesses because they have a clear idea of the market dynamics.
They have backed the Indian auto and ancillary sectors due to the rising export volumes of the latter and the higher profile of the former, given overseas acquisitions and alliances. They back Indian pharma and FMCG counters more willingly, where there’s a foreign parent or collaboration.
They seem to have developed some aversion to real estate stocks. Perhaps this is because the subprime crisis is not yet fully played out in the US, or perhaps because Indian real estate stocks are still starved for cash. This makes the overall market response to upcoming real estate initial public offerings a little more uncertain.
In many infrastructure-related industries, large overseas investments have come through debt, or private equity, or private placements, rather than secondary equity investments. Nevertheless, this is the next logical place for FII flows to go. The market has ample appetite for energy and telecomm stocks and entirely new plays in areas like city gas distribution are on the cards.
