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Aarati Krishnan

Domestic investors have been making use of the sharp rise in the equity values in the recent times to book profits on their earlier investments. This is a welcome trend and could help diminish the negative impression that investors have about investing in equity.

AS FII investments in India break new records, one question that crops up often is: will the FIIs stay with the Indian markets? The reason for the obsession with FII investment trends is clear. It is a widely held belief that the bull run will last as long as the FIIs pour in money but will begin to peter out, the day they begin to shift funds to greener pastures.

There is indeed a lot of truth in this belief. FIIs are the largest investors in the Indian stock market. But the common perception that domestic investors lack market-moving influence is not entirely based on fact.

Net flows misleading: If one considers the transactions by domestic mutual funds (MFs) in the equity market an indicator of domestic investor participation in the stock market, domestic investors have been active participants in recent times.

True, in 2003, as in the previous years, the numbers on net MF investments (gross purchases minus sales) in the equity market suggest that MF investments were down to a trickle, compared to FII flows. Till date in 2003, FIIs have made net equity investments of Rs 23,000 crore, while MFs have actually pulled out around Rs 1,100 crore on a net basis.

MFs do account for significant volumes: But this wide gulf between the two numbers is largely because while FII investments have been more of a one-way flow with a steady increase in the level of purchases from month to month. While MFs have indulged in heightened levels of both purchase and sales activity, with one cancelling out the other.

This has led to a low level of net investments by MFs. If one compares the total purchases and sales activity of MFs to the purchases and sales by FIIs, it is clear that MFs (and thus domestic investors) do account for a significant portion of the transaction volumes on the bourses.

Purchases gather steam: Take the monthly trends in purchases by MFs, for instance. In 2001, gross purchases by MFs accounted for no more than 23 per cent of the value of purchases made by the FIIs. In 2002, this proportion climbed to 33 per cent. In 2003, though FIIs have sharply scaled up their levels of investments, MFs too appear to have scaled up their purchases. MF purchases remained at over 30 per cent of the FII purchases, in value terms, in the first nine months of 2003.

This appears to indicate that domestic investors too have been fairly active participants in the equity markets. And investments routed through MFs obviously represent only a part of domestic investor interest in the equity market.

If MFs have accounted for significant volumes of purchases on the bourses, they have had an even higher share of the sales volumes.

Trends in monthly sales transactions by MFs suggest that their sales have consistently accounted for 45-55 per cent of FII sales in value terms over the past few months. Due to this trend, MFs have been net sellers on the bourses over the past three months, even as FIIs have turned aggressive buyers of equities.

This suggests that domestic investors have been offloading part of their equity holdings to the FIIs. In fact, this could be one reason why a pullout by the FIIs tends to pull the plug on a bull market. The MFs and domestic investors appear to adopt the sell mode when the market is on a high. So any pullout by FIIs only adds to the selling pressure, which already exists due to MF selling activity.

A healthy trend: But this trend (of heightened MF selling) is not necessarily an unhealthy trend for the Indian equity market.

For one, it shows that domestic investors have been making use of the sharp rise in the equity values in the recent times to book profits on their earlier investments.

Given that a major portion of investments in equity MFs have been made at Sensex levels of over 4000, this is a welcome trend, as it suggests that such investors are likely to have made a profit on their holdings. Second, the recent pullouts by MFs also reinforce the view that the MFs themselves are taking a more cautious stance in this bull market than they did in 2000.

Portfolio statements of leading MFs show that they appear to be adhering to a discipline of periodically taking profits on stocks, based on target price benchmarks for each of their holdings.

What is more, MFs have declared liberal dividend payouts on their equity schemes in the recent bull run, ensuring that their investors are able to periodically cash in on gains when the market is on the upswing.

Both these trends could help diminish the negative experience that domestic investors have, time and again, faced with equity investing.

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