The dichotomy in FPI and MF behaviour

Retail investors, who have been advised to follow the ‘smart money’ would be a bewildered lot this year. The ‘smart’ investors are the institutional investors who are supposed to know when to buy and when to sell and hence act as a beacon for the aam investor, looking for direction. But the two sets of smart investors in the Indian market — the foreign portfolio investors and mutual funds — have been behaving quite differently this year.

Even as the FPIs have been wowing the crowds by pouring record levels of money into Indian stocks this calendar, mutual funds have been net sellers; FPIs have net purchased stocks worth around ₹1,38,000 crore this year when mutual funds have net sold stocks amounting to ₹31,892.

Why is the behaviour of the two different this year? An analysis of FPI and MF flows since 2000 offers some answers. There is a certain pattern in the manner in which these two categories behave during sharp market declines and in recovery phases.

Covid crash and the recovery

Foreign portfolio investors were at the forefront, leading the selling in March this year and the 40 per cent decline in the Nifty50 from the January peak was mainly due to their net sales worth ₹61,973 crore. Mutual funds, on the other hand, were net buyers in March, purchasing stocks worth ₹30,285 crore.

In April and May, both FPIs and MFs behaved similarly as stocks formed a bottom. From June onwards, the disparity in the actions of the MFs and FPIs became stark, with the former continuing to sell while FPIs went on a buying spree.

Mutual funds appear to have been constrained by a few factors since April. One, given the heavy purchases made in March, they may have had little surplus to deploy thereafter, especially since equity-oriented funds have witnessed continued outflows in the second-half of 2020. Two, they could have been more circumspect about the prospects of the Indian companies given the earnings contraction and the impaired demand due to the lockdown.

Foreign investors, on the other hand, seem to have preferred parking their funds in India and China, the two countries that promised a faster recovery in 2021, given the larger domestic markets.

The twain rarely concur

The dichotomy in the behaviour of MFs and FPIs is, however, in line with the trend recorded since 2000. FPIs have typically led sharp market declines with their selling while mutual funds keep buying in such phases. But the recovery phase is also, in most instances, led by FPIs, with the MFs joining the party later.

This was evident in 2008, when the Nifty50 lost over 60 per cent from its peak. FPIs were in the forefront dragging stocks lower, by net selling ₹55,195 crore of stocks that year. Mutual funds had purchased stocks worth ₹14,331 crore in that period. But in the dramatic recovery in 2009, FPIs net purchased stocks valued at ₹84,013 crore while mutual funds turned hesitant, selling stocks worth ₹5,493 crore. This trend was once again repeated in the market decline in 2011 and the recovery in 2012 when MFs turned sellers when stock prices were recovering. The exception in recent times was in the recovery in 2016 following the decline in 2015. MF purchases were more than twice the FPI purchases then; due to the demonetisation, perhaps.

Why the difference?

FPI flows are closely linked to monetary policy of central banks; the liquidity infused by them through low interest rates and stimulus funding fuels these funds. FPI flows were at record levels between 2009 and 2014, then the quantitative easing programme of the Federal Reserve was in force. When Fed announced tapering of the stimulus, along with interest rate hikes, FPI flows whittled down in 2016 and 2017 and turned negative in 2018. The grand come-back of these flows can, therefore, be once again linked to rates in the US moving back to zero and the large stimulus to fight the Covid pandemic.

FPI flows into India are more sensitive to conditions in the US because investors from the US have the largest share of FPI assets. They are also more influenced by sentiments in global financial markets and that is the reason they push the sell button when global risk-off sentiment is high, as was witnessed in March this year. But once the recovery begins, they move towards countries with better economic prospects and that explains why FPIs have driven the market recovery in India.

Mutual fund investments, on the other hand, take a more stock- or sector-specific approach and hence these investors are quick to spot value in market corrections and buy during the bear phases. Inability to participate in the initial recovery is largely due to the caution due to recency bias, coupled with fund investors redeeming money.

Who should investors follow?

So, which smart money should investors follow? To get the answer to that question, we analysed the price movement of stocks in which FPIs and MFs increased stakes over three percentage points between April and September 2020.

Of the 29 stocks from the Nifty50 basket in which FPIs had increased stake significantly, 11 stocks delivered returns of over 100 per cent since April 2020. In contrast, the MFs increased stakes over three percentage points in 25 stocks of which only four delivered returns over 100 per cent. Average returns of the FPIs’ top picks was 104 per cent while the average return of MFs’ picks was 74 per cent.

It’s, therefore, obvious that in the short-term, FPIs wield greater influence on stock price moves. So, following FPIs in short-term investing makes sense. But mutual funds have the better ability to identify stocks that can deliver over the longer term. While opportunities in the large-cap space may be hard to come by, it makes sense to scour the portfolios of mid- and small-cap mutual funds from time to time to identify new additions.

This pattern of flows in market declines and recovery phases is actually good for the long-term trend in the market. Domestic funds will buttress the decline in bear phases while foreign investors will be ready to give a leg-up when conditions are bleak. This trend is likely to play out again and again, as long as India retains its demographic advantage.

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