Point blank . When will the FPIs stop selling?

Equity markets were gung-ho in the past two trading sessions, thanks to the monstrously large stimulus money promised by the US government to fight the Covid-19 pandemic. This would have come as a welcome respite to Indian investors who have been battered by incessant selling over the past month.

Surprisingly the mood among most domestic investors — fund managers, investment gurus, retail investors, et al — was quite upbeat during the decline. Most of them, at least when asked on camera, professed to be thrilled with the decline, which they claimed was a great opportunity to buy for the long-term. The driving force behind the over 30 per cent decline in the Sensex and the Nifty50 were Foreign Portfolio Investors (FPIs), who have net sold ₹41,657 crore of Indian equity so far this year.

With their holding of ₹28,86,931 crore of Indian stocks as of end-February 2020, accounting for 19 per cent of the total market capitalisation and 40 per cent of free-float market cap, they wield enormous clout over short-term price movement of Indian stocks.

So who are these foreign portfolio investors? Why are they selling now, and when are the selling likely to stop?

Foreign portfolio investors, when compared with foreign direct investors, have a relatively shorter investment horizon and are allowed to hold a lower stake in companies. FPIs, or FIIs as they were previously called, gained notoriety because most of the large declines in recent times — be it the 2008, 2006 or 2001 crash — had been led by them.

But it would be wrong to paint all FPIs with the same brush.

A look at the composition of the global investible pool reveals a large variation among these investors.

According to a report from TheCityUK (a financial services industry body), of the total assets of the global fund-management industry of $160.6 trillion in 2016, conventional funds including pension funds, mutual funds and insurance companies managed $101 trillion or 63 per cent.

Alternative funds (including include hedge funds, private equity funds and sovereign wealth funds) managed $17.3 trillion, and private wealth funds accounted for $63.5 trillion. About a third of private wealth was invested in conventional funds.

Hedge funds, that are the most touted source of volatility due to the exotic strategies employed by them, accounted for just $3 trillion or 1.65 per cent of the entire pool. The more opaque component is, however, the private wealth, that accounts for 35 per cent.

FPIs in India

In India, long term foreign portfolio investors, who are unlikely to churn their portfolios often — such as multilateral organisations, entities owned by governments and charitable organisations — owned around 16 per cent of total FPI assets towards the end of February 2020. This segment is unlikely to have participated in the sell-off in a material manner. Money that is likely to be more short-term, from hedge funds and unregulated funds, limited partnerships, trusts, etc., accounts for around 16 per cent of FPI assets. But due to tight regulation, influence of hedge funds over the Indian stock market has diminished materially in recent times.

The sharp drop in outstanding participatory notes too implies that there is little threat from foreign hedge funds to Indian markets.

The pool of non-transparent assets — belonging to private wealth or HNIs — that invests in India through broad-based funds located in low-tax offshore jurisdictions is also unlikely to flee Indian markets in such turbulent times, since these fund managers may be tied by their mandate to invest in India.

Through the process of elimination we can assume that the selling in this phase of market decline has been led by institutional investors such as mutual funds, exchange traded funds, pension and insurance funds; which own bulk of FPI assets.

Why are they selling?

The conventional funds such as mutual funds and ETFs (accounting for 46 per cent of FPI assets), pension funds (7 per cent) and insurance funds (1.29 per cent) do not take a direct call on Indian stocks but instead prefer to invest in India through indices such as the Global Emerging Market (GEM) index, Asia Pacific (APAC) or Asia-ex Japan index. These funds could be selling Indian equity due to three reasons. Redemption out of their funds due to the sharp drop in their net asset values (NAVs) would make these funds sell their holdings to repay their investors.

Two, the global risk-off sentiment could be making the managers reallocate funds from emerging market equities to home country assets. Around 46 per cent of global conventional assets belonged to the US, 8 per cent to Japan and 7 per cent to investors from the UK. So during risk-off phases, money is likely to flow back in to these countries.

Three, many investors using loans to invest in these funds would be forced to redeem their investments to repay the loans. This de-leveraging could also lead to selling. Globally, governments and central banks are trying everything they can to infuse liquidity and ensure that the economy does not sink into a morass.

The extremely low interest rates and the unlimited money that is going to be printed will stave off the immediate pressure on leveraged investors. Investors will also have no problem in rolling over the loans taken to finance the investments. The liquidity to equity investors will improve considerably and that can provide some reprieve to the market fall.

The most important factor weighing down investor sentiment at this juncture is the looming uncertainty over the economic consequence of the pandemic. With both the US and India not doing enough tests and thus understating the numbers, it is not clear how fast the contagion is spreading or low much longer it would last.

While the fear in global markets has abated somewhat over the past two sessions, it could resume if any fresh news about the pandemic surfaces. With countries curtailing movement of citizens and everyone fearing for their lives, it is unclear whether empty rhetoric or unlimited loans will help salvage the current situation.

It would be better if governments were transparent about the situation on the ground so that investors can gauge the worst- case scenario as far as the economic impact goes. That can bring the selling to an end. As long as the uncertainty continues, FPIs are likely to keep their fingers on the sell button.

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