Things you should know before taking cue from FII activity!

Apr 16, 2014

In this issue:
» High food prices push inflation up
» Does the 90/10 rule of investing work for you?
» Do Mr. Bernanke's comments make sense?
» Structural shift ahead for US mortgage lending business
» ...and more!

The buying and selling activity in stock markets is often driven by a lot of myths. While there is enough literature and anecdotes on the right way to invest and common investing mistakes, we all at some point of time have been victims of certain misconceptions that are widely prevalent. One such myth is that if foreign institutional investors (FIIs) are buying a stock, it must be good.

The recent rally in the Indian stock markets is a lot driven by FII inflows. The Indian equity markets are dancing to the tunes of FII and have taken a break from the economic fundamentals. Infact, the peaks and lows in the Indian markets have coincided with FII buying and selling activity. As per an article in Economic Times, among emerging markets where elections are due, FIIs' allocation to India at 35% stands the highest. It is obvious that this inflow of funds is more of a bet on election outcome than any improvement in the fundamentals of the Indian companies.

Retail investors, often in self doubt mode, may find it hard not to get carried away by FII enthusiasm. A common perception is that FII investment in a particular stock is backed by strong research and has some of the best brains behind the investment decisions. Afterall, they invest in bulk and apparently face higher risk. So does it not make sense to follow what they are doing?

The answer to why aping FIIs does not make sense lies in basics of investing. We all know that investment decisions should be based on an investor's return expectations, risk tolerance and investment horizon. And they are likely to be quite different for retail investors than they are for FIIs.

First, though on an absolute basis, Foreign Institutional Investors (FIIs) investments in a stock may seem huge, it is likely to form a very small percentage of the overall corpus of funds that they deal in. As such, their holding capacity and tolerance to risk varies from that of a retail investor. Hence, while a bad investment decision regarding a particular stock may not hurt FIIs much, the retail investors can end up burning their fingers. Also, the time horizon for FIIs could be very different from that for an individual investor. In such case, FIIs will not be much affected if the price of the stock they hold dips. On the other hand, a retail investor with no deep pockets and in need of liquidity can end up incurring losses on the same.

Further, return expectations for FIIs might be starkly different from that of a retail investor. When the yields in their own markets are low (which has mostly been the case with developed markets), FIIs would be happy to switch to Indian markets and earn relatively better returns. However, for retail investor in India, where returns on fixed deposits are relatively higher, investing in the stocks (in which FIIs are investing) might not justify the risk associated with equity investment.

Often, FIIs inflow or outflow in a particular market is driven more by external reasons such as US tapering, expectation of change in the Government etc. FIIs are quite quick and often the first to make an exit even on the speculations which may or may not be right. No wonder FII funds are often termed as hot money. By the time the retail investors get to know about it, the stock prices have already plummeted and they are left with losses. At the same time, if FIIs are exiting a stock, the reason may not be bad fundamentals, but their need for liquidity. If you end up copying their moves, you might lose on a good investment.

In short, the decision to invest in a particular stock should be driven by bottom up approach and a person's own investment profile such as return requirements, time horizon and risk tolerance. At the most, one may be watchful of FII activity in a stock and may use the knowledge to dig further whether the reasons for them are stock specific or driven by external factors. But by following FII investing activity blindly, you are more likely than not to burn your fingers.

Do you think that blindly following FII activity can help you earn good returns in equity markets ? Let us know in the Equitymaster Club or share your comments below.

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 Chart of the day
India's high inflation problem simply doesn't seem to end. As per an article in Economic Times, both wholesale price index (WPI) and consumer price index (CPI) increased more than expected in March 2014. As you can see in today's chart of the day, both the inflation indicators showed signs of abating in recent months. But the data for March has proved to be a wet blanket. What was the reason for the increase in the inflation level? The answer is increasing food prices. While the wholesale food inflation rose up to 9.9% in March, retail food inflation increased to 9.1%. Unseasonal rains in several parts of the country have disrupted food production. Moreover, the rising threat of El Nino on monsoon rainfall this year further increases inflation worries. Given these facts, the chances of a rate cut, seem to be dim, at least in the short to medium term.

Costlier food shoots inflation figure for March

Are you a reckless risk taker that invests in only the hottest IPOs and high flying sectors and is not averse to trading if required? Or are you a sensible long term investor who rarely takes risks and invests only in blue chip stocks and holds on to them for as long as their fundamentals are strong? We are sure most of you would have difficulties slotting yourself in just one of the two categories. For there's a strong chance that the long term investor in you took a backseat every once in a while and the risk taking investor took charge. So, the question is how come we are rarely able to resist our temptation to gamble in stocks even though we call ourselves a dyed in the wool long term investor?

Well, the answer has been traced to basic human nature. If the recent discoveries in behavioural psychology are to be believed, all of us have two systems in our brains and they are usually at conflict with each other. Therefore, instead of trying to tame one and make the other more dominant, how about catering to both of these systems? And this is where the entire 90/10 rule kicks in. The rule has been proposed by a commentator on It says that all of us should keep aside 10% of our money which can be used to execute high risk trades. The remaining 90% however, has to be one's retirement nest egg and never to be gambled with. This way then one can have all the fun and gamble one wants and at the same time ensuring that the very serious long term money is not hurt and is allowed to compound at a decent pace. Now, that's a suggestion worth implementing. What do you think?

The stress of bad loans had become too much to swallow for Indian Banks. So much so that some of them had to go ahead to take some unprecedented remedial steps. To put things in perspective, Indian banks recast nearly Rs 1 trillion worth of loans in FY14 alone. With this they took the total corporate debt restructuring (CDR) book to over Rs 4 trillion! Together with restructured assets, the total stressed assets in the sector touched 10.2% in December 2014. One would recall NPAs touching double digits way back in 2002. But since then the problem of bad lending has never been encountered to this extent. Hence by the time the sector realized the magnitude of the problem, it was already too late. The biggest bank, State Bank Of India (SBI), reported an NPA level of 5.7% for the December 2013 quarter. Facing sharp criticism, the bank chose to sell close to Rs 40 bn worth of bad loans to asset reconstruction companies! This is the first time the bank has done so in its over 100 year history. And apart from SBI, other banks too have cited their intention of selling bad assets. But getting rid of a high NPA level is solving just part of the problem. For the shareholders of the bank a lot of the value is already destroyed. For the banks selling the bad loans recovers just about 5-10% of the value of the loans in cash. Another 40-50% may be received in the form of security receipts. Thus a good portion of the bad loans are written off from the bank's net worth. Hence instead of assuming that the worst is over for Indian banks, investors need to remain cautious

Since the 2008 global crisis, the US Fed has resorted to a wave of quantitative easing. While this has certainly racked up the debt of the government, it has hardly done much in terms of bolstering the US economy. Indeed, this slush of liquidity instead found its way into the emerging markets having higher growth prospects and better returns. But that has had its share of problems for emerging economies. They have largely been at the mercy of hot money inflows. That is why when the Fed announced its intention to taper QE, significant chunk of the money was pulled out. This posed problems for central banks of the emerging economies including India. Indeed, RBI governor Mr Rajan was quite vocal about this and recently blamed the US Fed for its flawed monetary policies that had spillover effects for emerging nations. Former Fed chief Mr Bernanke, who has been the architect of QE, has not surprisingly refuted this. He opines that quantitative easing and similar policies can and have been effective for the economy. He further states that the reasons for asset bubbles lie elsewhere. We choose to view Mr Bernanke's comments with a pinch of salt. Especially when it is quite obvious that all of his loose monetary policies have hardly put the US on the recovery path.

Times are changing. And so are the mortgage lending volumes. The contraction in US mortgage lending business in recent periods has been steepest in the last 17 years. Higher interest rates and exorbitant housing prices have warded off the potential buyers away from the real estate markets. Mid-2013 marked the jump in mortgage rates with the Fed aiming to trim the stimulus spend. And subsequently the lending plunged like never before. And the lenders that had the penchant for mortgage lending to grow their businesses are now facing the harsh reality. Not just that! The lenders will now have to make a structural shift too. Essentially the business operations would now have to be smaller and leaner.

While the buyers and the lenders clamor about this fiasco, the investors are rejoicing. That's because they are counting on the potential rise in the quality real estate stocks that are cheaply available today. Well it seems that loss to one entity stands as a gain for the other!

For years India has been the global hub for manufacturing of gems and jewellery. But that heritage is now under threat from a combination of shifting market forces and new competitors, notably in China. China has risen as a serious competitor, setting up cutting centers and jewelry manufacturing facilities, and buying stones in bulk to take advantage of economies of scale. And now, according to an article in Business Standard, a large number of Indian jewellery manufacturing companies are considering a big investment plan in China, to make and export from there. While the cost of manufacturing is much the same in both countries, China has a long-term gold import policy and India does not. China also has supportive government policies. It is high time that the Indian government wakes up and takes measures to avoid another industry from becoming internationally uncompetitive.

In the meanwhile, the Indian stock markets that had opened on a positive note , slipped into the negative territory in the post noon session. At the time of writing, the benchmark BSE-Sensex was down by 200 points (-0.9%). Barring metals, all sectoral indices were trading in the red with realty and capital goods leading the pack of losers. Asian stock markets were trading mostly firm with markets in Japan being the biggest gainers. Most of the European markets opened the day on a strong note.

 Today's investing mantra
"Behind every stock is a company. Find out what it's doing." - Peter Lynch

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3 Responses to "Things you should know before taking cue from FII activity!"

virendra bapna

Apr 16, 2014



virendra bapna

Apr 16, 2014




Apr 16, 2014

The FII would make seduction process to make quick money with out loosing any thing. Better to keep away from the market and watch the TV.

Equitymaster requests your view! Post a comment on "Things you should know before taking cue from FII activity!". Click here!