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Aarati Krishnan

Whenever Indian stocks go into a free fall on selling by FIIs, all eyes immediately turn to domestic mutual funds to see if they can do a rescue act. Collections mopped up by new funds and the cash coffers of the older equity funds are then eagerly dissected to see if domestic funds can step in where the FIIs left off.

But despite a sharp ramp-up in the size of equity assets managed by them, domestic mutual funds continue to be dwarfed by FIIs in their ability to move Indian markets.

This, and other interesting trends were revealed in an analysis by Business Line of the trading patterns and shareholding of mutual funds and that of FIIs over the past two years.

Domestic equity funds have ramped up their average monthly purchases of Indian stocks from a measly Rs 3,000 crore in 2003-04 to over Rs 17,000 crore in 2007-08 — a four-fold increase.

But this hasn’t helped them wield greater influence on market movements. For, FII buy has shot up nearly sevenfold over the same period to hover at about Rs 75,000 crore a month (even in the wobbly month of March ‘08). Both numbers are on a gross basis to capture the actual transaction volumes.

These numbers suggest that in a choppy market, you need to pay more attention to the India “overweight” or “underweight” calls of leading foreign institutional investors, than to the soothing noises made by fund managers back home.

FIIs appear to have taken a much more consistent as well as bullish view of the Indian market than the domestic MF managers. Sample these numbers.

FIIs have been net buyers in Indian stocks in 53 of the 63 months since the bull-run began in early 2003. Bouts of net selling by them have been few and far between, confined to brief episodes in August 2007, November 2007 and, recently, January 2008.

In contrast, domestic funds have alternated between bouts of selling and buying throughout this five-year bull-run.

They’ve sold stocks (on a net basis) in 28 of the above 63 months, about a third of the time. This suggests that domestic fund managers may be churning their portfolios, and taking profit-booking opportunities more frequently than the FIIs.

One key point to note here is that the periodic bouts of mutual fund selling on the bourses cannot be blamed on the retail investors in MF schemes. In fact, trends in inflows into equity funds suggest that far from panicking, retail investors have pumped in higher amounts into equity funds in the choppy markets of January, February and March 2008. MFs however, net sold stocks in two of these months.

This suggests that mutual fund selling activity may be triggered by dividend payouts or the managers’ view on the market, rather than by forced redemptions.

Unexpectedly, domestic fund managers and FIIs seem to have diametrically opposing views on the markets. Months of heavy FII selling have usually seen domestic MFs buying into stocks.

August and November 2007 and January 2008 are clear instances where MFs lapped up stocks while FIIs were on a selling spree.

And, conversely, the months of September and October 2007 and March 2008 saw MFs in the exit mode even as FIIs bought into stocks. However, bouts of selling or buying by domestic MFs haven’t had much impact on market direction.

For instance, MFs were net sellers in September and October 2007, a period when the Sensex rose by nearly 30 per cent on the back of heavy inflows from FIIs.

On the other hand, January 2008 saw a massive correction in stocks (the Sensex suffered a 13 per cent loss), despite MFs making their till date biggest monthly net purchases of Rs 7,700 crore.

FIIs were net sellers to the tune of Rs 17,000 crore that month.

Corrective phases in the market have usually been triggered by FII selling, rather than by domestic funds exiting stocks. This explains why “global cues” rather than domestic developments, seem to hold so much sway over Indian stocks.

As long as the FIIs remained in the ‘buy’ mode, they were able to easily absorb any selling pressure unleashed by domestic funds.

The ultimate discomfiting takeaway from these numbers is that domestic fund managers, however bullish their view on the home markets, may not be able to save the day if the FIIs continue to be in a bearish mood.

The limited influence that MFs wield over individual stocks compared to their foreign peers is also evident from the share of market cap held by them. Domestic mutual funds hold just 3.7 per cent of the total market capitalisation of NSE-listed companies today; while FIIs hold almost four times as much — 15.2 per cent.

This is based on the latest shareholding patterns disclosed by companies to the exchanges. As expected, FII dominance is the highest with large-cap stocks (market capitalisation of over Rs 10,000 crore). FIIs hold a big 15.7 per cent slice of this pie, while MFs make do with a tiny wedge of 3.2 per cent.

Domestic fund managers do have a clear partiality for mid-cap stocks, with high allocations to them relative to large-caps in their equity fund portfolios. But, contrary to what you would expect, this doesn’t give them greater buying power in this space.

FIIs, over the years, have deepened their investments well into the mid-cap space too and now hold as much as 15.6 per cent of the market capitalisation of the mid-cap universe (market cap of Rs 2,500 to Rs 10,000 crore). Mutual funds are far behind (see Table).

The one segment of the market in which MFs do compare to FIIs in terms of their equity stake is in small and micro-cap stocks. MFs hold 3.8 per cent of the small-cap universe (stocks with a market cap of Rs 1,000 crore or less), while FIIs hold 6.9 per cent.

More Stories on : Mutual Funds | Insight | Foreign Institutional Investors | Stock Markets

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