Foreign institutional investors or FIIs are companies registered outside India, entering the domestic financial markets. These FIIs include hedge funds, pension funds and mutual funds. Any investment by an FII is generally in millions of dollars, which raises the inevitable question: what do FII movements and investments have to do with the small investor, who invests, at the most, a few lakhs of rupees?

Take a look at this: in the past 49 months there has been more than $41 trillion worth of FII funds invested in India. This has aided the recent bull run, and the market has seen unprecedented growth with the BSE Sensex rising 221% in absolute terms in this span. Obviously, investments by FIIs matters to the market, which then affects us.

A look at FII investment in January, then, tells a dismal story. Between 16 and 24 January, some $3.6 billion was taken out by FIIs. What’s most important is how this net selling affects us as retail investors. Should we take our cue from these investors and exit the market now? Economist Surjit S. Bhalla says no.

Concurs Tridib Pathak, CIO, Lotus India Mutual Fund: “There is a lot of value in this market and fundamentally, there is a lot of upside in it. For long-term value investors, there’s little cause for worry.” Adds Nilesh Jasani, research analyst, Credit Suisse: “Investors should remain invested in sectors where underlying earnings growth has little to do with financial markets or global economy.” However, as any market strategist will tell you, it’s always good to keep an eye on what the big movers are doing.

So, why are the FIIs turning sellers? There are several reasons given for this flight, but there are three predominant factors that are cited as being largely responsible. We take a look.

Re-rating India

The swings in the market forced several FIIs to withdraw from India and park their dollars in other emerging markets. Most of those fleeing India have shifted their attention to Uruguay, Russia, the Ukraine, and several other former Soviet countries.

Though there have been swings in the past too—July and October 2007 being the recent ones—FII response this time was different because of margin pressures back home. Most analysts say many FIIs have a mandate to provide regular returns to their investors. The Indian markets are not seen as a good short-term bet any more. India is seen as a good investment for the medium to long term. That’s because, despite its recent dismal performance, India has outperformed most Asian markets (excluding Indonesia and Malaysia), says a Deutsche Bank report.

More than a guest As the first graph shows, FII movements have driven stock prices till very recently.But data and experts suggest that their influence is getting less strong.

 

Fear of earnings slowdown

Analysts dismiss this fear in light of corporate India’s third quarter results. However, FIIs seem to fear the pace of growth and the fundamentals of the markets. Most FIIs are looking at corporate governance and execution abilities, which could be significant drivers in creating a strong portfolio of Indian stocks.

Recent action taken by the market regulator indicates that the Indian government would like to moderate the inflow of FII money. Again, these are fears of only a few FIIs, as average FII redemptions in India have been lower than in other Asian economies. Rather than a wholesale FII exit, analysts suggest that these institutions are just becoming choosy.

“Valuations are very attractive on a selective basis, and stock picking has to be done based on evaluation of business fundamentals,” says S Naren, senior vice-president and head of equities, ICICI Prudential.

Fear of a global slowdown

The subprime issue and problems in the credit markets have raised concerns about potential growth slowdown in the US and Europe.

The fear of a slowdown will likely continue to weigh on markets and stocks. “The Indian economy has sufficient internal ballast so that it won’t be blown off course, but it will lose some momentum,” says Jasani. This matters to FIIs who are investing billions of dollars. For the retail investor, however, a recession in the US will not really make a difference.

Exports account for 13% of India’s GDP, with only 15% of this going to the US. Clearly, some USexposed export sectors such as IT services and textiles will live in the shadow of a slowdown in the US. Nevertheless, India’s overall export intensity is among the lowest in the region. Says Sukumar Rajah, CIO, Franklin Equity: “India is among the economies less sensitive to a deceleration in US growth and one should not be perturbed by FII flows in either direction.” Some analysts also feel that a US slowdown may in fact increase outsourcing to India. All this apart, a global economic turmoil will make stock markets nervous time to time.