How do FII Investments affect stock market?

by Manshu on April 2, 2012

in Economy

The common wisdom is that the stock market goes up when FIIs pump money and it goes down when they take their money out.

While this is true, looking at the FII investment data for the last decade shows that it is not a simple, straight relationship.

Here is a chart that shows how much money FIIs pumped into equities in each of the last 10 calendar years, and how much Nifty moved in that year. The FII investments are in Rupees Crores, and the Nifty movement is percentage change.

FiI Investments and Effect on Stock Market Returns

FiI Investments and Effect on Stock Market Returns

To me, this chart shows the following things about the effects of FII investments on the stock market:

FIIs pulling money from the market has resulted in a fall

There were only two instances in the last decade where FIIs pulled out money from the stock market and at both these times the stock market went down. The pullout was fairly severe in 2008, and the market fall was very bad as well. You may argue that just two years aren’t enough to form a conclusion but I’d say that it is fairly safe to say that if FIIs were to pull out money then the stock market will go down.

Net positive investments by FIIs don’t guarantee an upmarket

The market fell in 2001 and FIIs were actually net buyers in that year so that also shows that the market can fall even if FIIs pump in money, so just positive net investments from FIIs don’t guarantee an up market.

Biggest up moves don’t coincide with biggest FII inflows

One thing that struck me about this chart is that the biggest bars don’t coincide with sharp up-movements in the line. The biggest percentage gains in the Nifty weren’t always in the same year when FII investments were at a peak.

If you look at 2003 – the market went up quite a bit, and there were healthy inflows as well, but if you look at 2004, there were bigger inflows but the market didn’t rise up as much that year.

Similarly, 2009 and 2010 follow the same pattern. I think this can be explained with the high base effect since the market rose so much in 2003 and 2009 that there wasn’t as much room to grow in 2004 and 2010, but all the same this wasn’t something that I understood intuitively before making this chart.

You hear and read a lot about FIIs dominating the stock market movements, and that led me to believe that each big bar will coincide with a sharp rise in the line as well, which is not the case.

Some thoughts on FII Investments

Normally you hear a lot about FII investments when markets fall and people cry hoarse about Indian markets being slaves to FIIs but when the market is going up, no one complains about FIIs pumping money!

I feel that you need to look beyond these moves and think about FII and FDI investments much more holistically.

FII money is to some extent hot money especially when invested in equities and by the very nature of that investment it will be volatile. Unfortunately, India’s current account deficit has been financed by FII and FDI inflows and given the government’s serious inability to pass any policy reforms that boost FDI – FII flows become even more important. It is delusional to think they’re not important, and that India doesn’t need them.

But the other side of the coin is that the west will see slower growth rates than emerging countries like Brazil, Mexico, India or even Mongolia and therefore western pension funds and hedge funds need access to markets like India where the rate of growth is likely to be higher than their home countries.

Both sides need each other, and if policies are executed properly – this will be a win – win situation for everyone involved.

Finally, here is the raw data for the chart above.

Year Annual Return FII Investment in Equities
2001 -18 11970
2002 6 3629
2003 67 30459
2004 12 38965
2005 36 47181
2006 40 36540
2007 53 71486
2008 -54 -52987
2009 81 83424
2010 15.5 133526
2011 -25 -2812

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{ 10 comments… read them below or add one }

Shinu April 2, 2012 at 4:20 pm

FII’s are a great trigger defenitely but is heartening to see the DII pullout the same time. Eagerly waiting to see last month figures. Poor administration of finances or manipulation. Dosent look good for long term i believe, as it dosent benefit the small indian investors which should help the multiple effect in years to come.

Reply

Manshu April 2, 2012 at 5:17 pm

I think you meant disheartening? Also, FII & DII have moved in opposite directions as far as net buys and sells are concerned.

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Shinu April 4, 2012 at 6:56 pm

Yes Sir.. :).

Nice to see the AMC numbers with its performance. See the jump in HDFC with that of many others who are underperforming and more deeply in performing funds. Hope the volitility will streamline the good ones and will bring in more and more new investors rather than numerus meaningless funds and fund houses riun the cocept itself, which should lead to a situation where the FII flows is not the factor to monitor at anytime.

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Ams April 2, 2012 at 4:23 pm

Very nice post Manshu. I too always thought that FII were main reasons for market movement, so this information has surprised me.
Does this also demonstrate the panic in the market when FII’s pull out the money from the market ?

Reply

Manshu April 2, 2012 at 5:16 pm

I guess it does but then you could say that when there is panic in the market everyone including FIIs pull their money so which is the cause and which is the effect? :-)

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Ams April 2, 2012 at 5:36 pm

Very interesting post. Thanks Manshu for this post, I too always felt that the FII’s where the ones driving the market movements. The dip can be understood based on panic too, as if the FII’s start pulling out money then it would leave a wave of negative sentiments and drive the market down.

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Rakesh April 2, 2012 at 5:47 pm

Manshu,

Thanks for compiling everything, good analysis. Over the last 3 years
FII’s invested a lot more than they took out in 2008 but we never reached the heights of 2007.

2008 -54 -52987
2009 81 83424
2010 15.5 133526

Reply

Manshu April 2, 2012 at 7:16 pm

Another interesting thing about the FII data but something that is not visible here is that FIIs have also started investing in debt instruments a lot in the past few years. I think a large part of that is triggered by rule changes, and I plan to have a post on that as well.

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Rajeev April 2, 2012 at 6:57 pm

Good data points. Would love to see your POV (based on this data) that non-savvy investors can use.
cheers.

Reply

Manshu April 2, 2012 at 7:15 pm

I don’t think an investor can really use this data beneficially because you don’t know in advance what’s going to happen and base your move on that.

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