The Hindu Business Line : How FIIs dealt with their portfolios in Q1

Do you take cues from foreign institutional investors (FII) to make your stock choices? If you do, you are probably breathless from trying to keep pace with their flighty movements in the last two quarters. First, FIIs pumped in close to $6 billion between October and December. Then, they pulled out almost half that sum between January and March this year.

The sharp about-turn in fund flows has caused a significant re-jig in the holdings of FIIs, as revealed by a Business Line study of the latest shareholding pattern of companies constituting the BSE-500.

Stocks in the mid-cap space appear to have borne the brunt of FII selling pressure. But at the same time, FIIs continued to add to their holdings in select mid- and small-cap stocks. What’s more, the views of domestic mutual fund managers appear to be contrary to those of foreign investors. Some key findings from the study are summarised below.

Significant re-jig

The FII sell-off between January and March this year took almost $3 billion off the market and was the longest and most intense period of selling since the stock rally began in 2003. But foreign institutional investors still remain significant shareholders in the BSE-500.

FIIs owned 15 per cent of the BSE-500 basket as on March 31, 2008, almost the same as the immediately preceding quarter ended December 2007. Their holdings straddle almost the entire BSE-500 basket, barring a handful of stocks.

However, FII views on individual stocks in the basket have clearly changed, and that too in a single quarter. Foreign investors either hiked or reduced their holdings (by more than one percentage point) in 223 companies in the first quarter of 2008. As is to be expected from their activity during this period, they sold more shares than they bought.

FIIs cut exposure in 139 stocks, while increasing their stake in 84. Just the preceding quarter, FIIs made equally significant changes to their portfolio. Only, they were buyers then and had upped their stakes in nearly a third of the stocks constituting the index.

The change in view has been particularly sudden in stocks such as Firstsource Solutions, Ganesh Housing, Elder Pharma and Sasken Communications. FII’s trimmed their holdings in these stocks by more than 10 percentage points for the latest quarter. Madras Cements was the only stock, however, from which FIIs exited completely.

Pressures back home did not prevent foreign investors from significantly hiking their holdings in stocks such as Gitanjali Gems, Rajesh Exports, Monnet Ispat, Core Projects and Power Trading Corporation. FII stakes in these companies rose by 6-15 per cent. Part of the increase in FII holdings in these stocks may have been on account of foreign currency bonds being converted into equity during the quarter or upon preferential allotment of equity to foreign investors. But, even adjusting for these allotments, the FII stake increase in these companies is quite significant.

Mid-caps lose favour

As some of the “buys” mentioned above might suggest, FIIs did not shy away from small-cap stocks (market capitalisation of less than Rs 1,000 crore), despite their heightened aversion to risk. Instead of pruning it, they merely reconstituted their small-cap portfolio. Although they cut exposures in 19 stocks, they hiked stakes in 24. Mid-cap stocks (market capitalisation between Rs 2,500 crore and Rs 8,500 crore), on the other hand, saw significantly more sells and fewer buys.

The fact that FIIs increased their holdings in stocks such as McNally Bharat, Prime Focus, Gati, Nucleus Software, ICSA India and KS Oils, suggests that mid-cap and small-cap stocks are still on their radar. The top ten stocks by FII holdings in the last two years have sported a mix of large-, mid- and small-cap stocks. This is probably a reason why mid-cap and small-cap stocks should find a place in one’s portfolio as well. However, these category of stocks are far more vulnerable to changes in FII sentiment than large-caps.

Expectedly, large-caps (top 100 stocks by market capitalisation) saw the least changes in FII holdings in these volatile quarters. Ranbaxy, Sesa Goa, Tata Power and Axis Bank were some of the large-cap stocks in which foreign investors hiked ownership significantly in the March quarter.

Mutual funds differ

While foreign investors overhauled their portfolios, domestic mutual fund managers made some changes in their portfolios as well, as they dealt with a more volatile market and investor redemptions. A quick analysis of the changes in mutual fund holdings in the BSE-500 basket reveals an interesting trend: mutual funds and FIIs have taken opposing views on stocks in several instances.

Sample this. In close to 50 stocks in which FIIs have pared exposures, mutual funds added to their holdings. The reduction in FII holdings in stocks such as Cairn India, Balrampur Chini and Nagarjuna Construction during the March quarter was almost completely offset by the investment from mutual funds, suggesting that shares changed hands between the FIIs and MFs.

This disparity in views is not altogether surprising when one considers the trends in FII and mutual fund flows into equities over the past couple of years.

An earlier study by Business Line (see “FIIs are still the Kings” Business Line, April 20, 2008) shows that mutual funds are often net buyers when foreign investors sell, and vice-versa.

Notably, however, not all stocks added by FIIs during the quarter have been offloaded by mutual funds. This seems to suggest that domestic fund managers were mainly trying to take advantage of the FII sell-off to enhance their exposure to select stocks.

In some instances, FIIs’ loss was domestic fund managers’ gain. Cairn India, Balrampur Chini, Punj Lloyd, Lloyd Electric, Bombay Dyeing and Mercator Lines were offloaded by FIIs and mopped up by mutual funds during the January-March quarter. These stocks have been out-performers since March 31.

Sector positions

Foreign investors have been very selective in their buying and appear to have taken a stock-specific rather than sector-driven approach in re-constituting their portfolios. This is evident from the divergence in buys and sells within each sector.

For instance, while FIIs have cut exposures to most banking stocks, they have added stocks such as Axis Bank, Federal Bank, Yes Bank and Karnataka Bank. Similarly, select pharmaceutical and mid-cap IT stocks found favour with FIIs.

Construction and real estate stocks, however, largely came under the FII axe.

Again, FIIs differ from mutual funds in terms of sector weights as well. Banking and finance stocks accounted for nearly 25 per cent of FII holdings as of March. Other prominent sectors in the FII portfolio include oil, IT and telecom. Mutual funds, on the other hand, have a higher exposure to capital goods and construction stocks relative to FIIs and are underweight in IT and telecom. The significant changes in the FII shareholding pattern in a single quarter might make you want to rethink the strategy of following their every move. After all, if they are going to change their mind the next quarter, what is the point?

Exceptional period

However, the last two quarters have been exceptional ones, as both the foreign inflows in the preceding quarter and the outflows in January-March were unprecedented. It is also well-known that this activity was triggered by the unexpected magnitude of the sub-prime crisis.

An analysis over a longer period may reveal that FIIs do tend to take long-term views on stocks. In a market where foreign investors dwarf domestic institutional investors, taking cues from FIIs, therefore, does pay.

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