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Which set of investors would you follow?
Mar 4, 2015

NSE-Nifty touches 9,000! BSE-Sensex today crossed the 30,000 mark! Times are good. Investors have made money. And there is a good amount of feel good factor prevailing around.

But do pardon us for trying to make the same disappear...

This we say as we came across an interesting chart in today's Economic Times; one that shows that domestic investor participation has made a comeback. But at the same time, that of the foreign institutional investors (FIIs) has come down and how!

The chart below shows FII and domestic mutual fund flow at various levels of the Nifty - 5,000 to 6,000, 6,000 to 7000... and so on, right up to the 9,000 levels which is touched very recently.

And the trend that we see is something that has time and again been the case in previous market run ups and cycles. When markets perform poorly, it's the 'smart' money that comes in (FIIs), while the relatively naive investors tend to cash out as the losses and volatility gets too much for them to handle, thereby exiting stocks altogether.

As the chart shows, FIIs pumped in as much as Rs 2.4 trillion into Indian stocks when the Nifty was hovering in the 4K to 5K range (a period which lasted for about 765 days). This then declined to Rs 1.6 trillion when the index moved around in the range of 5K to 6K range (for almost one year); As the index rose, the investments by this set of investors came down. At a time when the market is trading at about 8K to 9K levels, this set of investors only pumped in Rs 463 bn.

On the other hand, in case of retail investors - who can be represented by the actions of domestic mutual funds - the story is quite the opposite. When the markets were languishing, this set of investors in fact began cashing out their positions. But as and when markets rose, that's when they returned and thereby allocations turned positive in recent months.

This odd retail investor behavior is something that we at Equitymaster have been highlighting for years now. In fact even recently, Daily Reckoning author Vivek Kaul had written an article about how retail investors tend to get their timing wrong almost every time. An excerpt from it is as follows:-

    Economic theory tells us that more often than not, higher prices dampen demand and lower prices increase demand. But when the stock market witnesses a bull run, investors do not behave like normal consumers.

    As Mahar puts it in Bull! "In the normal course of things, higher prices dampen desire. When lamb becomes too dear, consumers eat chicken; when the price of gasoline soars, people take fewer vacations. Conversely, lower prices usually whet our interest: color TVs, VCRs, and cell phones became more popular as they became more affordable. But when a stock market soars, investors do not behave like consumers. They are consumed by stocks. Equities seem to appeal to the perversity of human desire. The more costly the prize, the greater the allure."

We are at an interesting point in the market we believe. While broader valuations are rising, the same is not being seen in the case of earnings.

What should investors do? Well... be cautious is what we would say. Not being fully invested would be a good action plan given the situation at the moment. Firm believers in bottom up investing, we at Equitymaster are of the view that gauging the risk reward ratio before making an investment decision would be the way to go about things, especially at a time when the broader market is bordering on the frothy zone.

Why do retail investors usually tend to get their timing wrong?

Data source: Economic Times

This Chart Of The Day was published in The 5 Minute WrapUp - Who's looking smart right now - FIIs or retail investors?

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