Who's looking smart right now - FIIs or retail investors?
(Mar 4, 2015)
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In this issue:
» Seth Klarman on what he has learn from Buffett
» The stock of ITC goes to the cleaners!
» Dr. Rajan's surprises with another rate cut today
» ...and more!
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.
Which set of investors would you follow?
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.
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.
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."
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? Let us know your comments or share your views in the Equitymaster Club.
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Continuing with our discussion on investing approaches, we thought it would be a good idea to highlight some points that investing great Seth Klarman wrote (on www.ft.com) discussing the key lessons he has learnt from Warren Buffett. We have tried to cover the key ones that may be relevant in today's scenario:
Mr. Klarman in fact touched upon the last point in this latest letter to investors wherein he wrote that tending to risk management is of "paramount importance" to prepare for the next bear market. And that it would make sense to not force money into new investments. Klarman has been sharing his views on the overheated US market for a while now. He recently noted:
- There is no need to overly diversify. Invest like you have a single, lifetime "punch card" with only 20 punches, so make each one count. Look broadly for opportunity, which can be found globally and in unexpected industries and structures.
- Holding cash in the absence of opportunity makes sense.
- To the extent possible, find and retain like-minded shareholders (and for investment managers, investors) to liberate yourself from short-term performance pressures.
- Unprecedented events occur with some regularity, so be prepared.
'A value investor's task in 2014 was made more difficult by these loose money policies and the resultant tide of bullishness.
As we have highlighted in many articles in the past, the overheated scenario in the US is a concern for the Indian markets considering the strong influence of the FIIs. Taking the necessary precautions would not be a bad idea after all, is what we believe.
For six years and counting, optimists have been relentlessly rewarded, and skeptics punished.
Our caution continues to be an ongoing and unavoidable drag on current investment performance. We remain determined to avoid speculation, while maintaining our disciplined, long-term orientation.'
While most investors are busy celebrating Sensex reaching 30k at the moment, there would be few for whom this silver lining has come with a somewhat dark cloud we reckon. It is the investors in the blue chip stock of ITC we are referring to. As per a leading daily, the cigarettes to hotels conglomerate has lost 13% of its market value. Or to put it differently, close to Rs 400 bn of its market cap has been shaved off since budget day. The culprit of course is the yearly ritual of raising the excise duty on cigarettes by the Finance Minister. For the past few years though, the rise has been relatively more punitive and has in fact taken a toll on volumes. Therefore, fearing further pressure on the company's topline, investors seemed to have taken a dim view of things and have sent the stock to the cleaners. Now, if one puts on the hat of a long term investor and then re-assesses the situation, the conclusion that can be reached is that no matter how steep the excise hikes, it will be very difficult indeed to wean people away from smoking. And thus at the right price, the stock may continue to give good returns over the long term. Therefore, a possible assessment of risk-reward, especially in light of the recent correction is definitely in order we reckon.
Are we about to enter a virtuous cycle of growth and low inflation? Well, this possibility got a good boost in the recently announced Union Budget where the Finance Minister repeated his Government's commitment of not straying from the fiscal road map. And now lo and behold, even the RBI has decided to give its stamp of approval to such a move. In what came as a pleasant surprise to investors today, India's central bank cut repo rate by 25 basis points. Well, this could give GDP growth another booster shot if you ask us.
Please note that what must have also led Rajan to take such a step would be easing inflation in the country. And what more, there's a strong possibility of the same remaining low for an extended period of time. Consequently, the onus is now on the Government to create an enabling environment. And of course, the corporates also need to take advantage of this and start investing in growth and capacity expansion. However, this is no time to uncork the bubbly just yet we believe. Any delay in important reforms or the Government going back on its fiscal promise for reasons not under its control and we will be back to square one. As a result, it's better to be cautiously optimistic at the moment.
After starting the day on a firm note, the Indian stock market went in a sell off mode as the Sensex dropped below the dotted line in the post lunch session. At the time of writing the BSE-Sensex was trading lower by about 0.6% or 166 points. Stocks from the mid and smallcap spaces were trading weak too with the representative indices trading lower by about 1% each.
"The focus of most investors differs from that of value investors. Most investors are primarily oriented toward return, how much they can make and pay little attention to risk, how much they can lose" - Seth Klarman
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