The sharp correction in the month of August and the first week of September had a deeper sub-plot written into it. At a time when the FPIs were selling and exiting the Indian market in droves, domestic mutual funds and insurance companies were buying aggressively. Let us looking at some statistics! During the month of August 2015, FPI net selling was to the tune of Rs.19,500 crore; predominantly in equities and only marginally in debt. During the same month, domestic financial institutions were net buyers in equities to the tune of Rs.16,500 crore. If you consider from the beginning of the calendar year, the disparity between FPIs and DFIs is a lot more glaring. FPIs were net buyers to the tune of $1 billion; largely due to the frenetic buying around the Union Budget. During the same period, DFIs were net buyers to the tune of a whopping $7 billion. One can imagine how deep the correction would have been on Indian bourses had the domestic funds not supported the market. There are a few interesting areas of discussion that emerge.
Can the DFIs sustain the Indian markets?
First let us consider some interesting statistics. Equity mutual funds saw inflows of $12 billion during the financial year 2014-15; or an average of $1 billion per month. This was after almost 6 years of negative inflows into equity mutual funds. During the first few months of fiscal year 2015-16, the average monthly inflows have been in the range of $ 1.5 billion to $2 billion. That surely makes them a force to reckon with. But the real challenge could come from the fact that mutual funds own just about 3.3% of Indian equities whereas FPIs own over 25% of Indian equities. That surely gives the FPIs a much larger sphere of influence. LIC is a major shareholder, but it is more of a passive player in the market and is more of a long-term accumulator of stocks.
Don’t forget the role in derivatives…
Looking at equities alone may give a slightly misleading picture. FPIs have a major role to play in the derivatives market. For example, domestic mutual funds were significant players in the derivatives market till 2008. The situation changed drastically when the outflows began and the arbitrage funds were the worst hit. By 2014, the domestic mutual funds had become marginal players in the derivative markets. The derivative markets are significant for two reasons. It provides a proxy for the actual equity markets and the use of options and futures allows the FPIs to design a variety of esoteric strategies. Today the Futures and Options market is almost 90-95% of the daily volumes and the institutional segment of F&O is largely dominated by the FPIs. This segment has an inordinate influence on the equity market and that impact is normally not captured when we merely look at statistics of equity selling and buying.
A bigger canvas to play on…
FPIs have the advantage of being present in multiple geographies and that gives them the benefit of multiple trading platforms. This can be significant in a variety of ways. Firstly, domestic mutual funds are largely dependent on retail and HNI flows as far as equity inflows are concerned. Most corporate inflows are largely into debt and treasury products. FPIs, on the other hand, have the leeway to borrow in low interest rate markets and invest the money in India. Popularly known as carry-trade, this enables these FPIs to bet on rate movements and earn a clear spread with large volumes. This is one of the reasons Indian markets tend to be highly vulnerable to any unwind of carry trades; as we saw in the last couple of weeks after China devalued the Yuan.
Secondly, FPIs have greater flexibility in structuring spreads. For example, they can arbitrage between the Indian Nifty and the SGX Nifty in Singapore. More often than not, this gives them a risk-less arbitrage. That is something most Indian funds do not have the flexibility to offer. Secondly FPIs can invest in their own proprietary accounts as well as for clients through the issue of overseas derivative instruments (ODIs). This kind of flexibility provides a much larger canvass for the FPIs to influence the Indian markets.
So, FPIs will continue to be very significant…
The moral of the story, therefore, is that FPIs will continue to be very significant players influencing the Indian markets. While mutual funds are surely emerging as a significant force, they still have a long way to go as they lack the broad canvas that the FPIs possess. But for the time being, the domestic institutions are at least holding the Indian markets from a virtual free fall. That is good enough!
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