Few pieces of market information attract as much attention in India as the daily record of institutional buying and selling. Investors who study the fii dii data are essentially trying to understand who is supplying and who is absorbing shares at any moment. Alongside that, many traders keep a close watch on the Nifty Bank because financial stocks carry heavy weight in benchmark indices. Used wisely, such information can improve awareness; used carelessly, it can encourage costly overtrading.
Why Patterns Matter More Than Single Days
A single day of heavy selling is often worrying, but it could just be portfolio rebalancing, or a large block deal. It is more useful to look at weekly and monthly trends. When one category of investors is consistently net sellers and the other is buying, the market tends to consolidate as buyers and sellers balance each other out. See if you can plot cumulative monthly inflows and outflows and compare it to the index. In many cases, even when overseas funds are net sellers, the domestic market has sucked in enough money to push the index higher. This means that the ownership pattern of the domestic market has changed, with increased participation from retail investors via mutual funds and direct investments. These investors have more staying power than overseas institutions.
Read on for behavioural differences between the two categories of investors
Overseas investors are often more reactive to changes in the relative appeal of different markets. They tend to reshuffle quickly in response to movements in currencies, commodities, interest rates and risk appetite. Decisions are made at a country and sector level, rather than stock-specific allocations.
Domestic mutual funds have a more consistent bias towards certain sectors, and tend to have a longer time horizon. They also have monthly inflows that get immediately allocated to stocks. Domestic insurers have a very long time horizon, and tend to gravitate towards sectors with consistent earnings. Thus, on down days, domestic institutional investors tend to buy the dip. Understanding this can help you understand why markets behave the way they do.
Sector rotation
In general, institutional investors have sector biases. During periods of optimism about the economy, sectors like banking, capital goods and infrastructure see inflows. During periods of caution, there is more money flowing into defensive sectors such as consumer staples, pharma and IT.
Check out sector-wise fund flows, which some regulators and newspapers report from time to time. If there is consistent buying in a particular sector, it could be a sign that institutions are getting more comfortable with the outlook for that area. It could also indicate that fundamentals have improved, or valuations have become appealing. However, just because institutions are buying a sector does not mean you should jump on the bandwagon. Remember that many institutional investors also get caught out in market corrections, and the money flowing into a sector could reverse as suddenly as it came. By the time you notice the trend, it could well be too late to benefit from it.
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Avoid these common mistakes while reading the tea leaves of institutional investors
Don’t mistake fund flows for forecasts. The information is useful, but it primarily reflects what has happened, rather than what is likely to happen next. Avoid extrapolating the trend. Another mistake is to ignore valuations. Even if a sector has been gaining strength, it could still turn south if the broader market conditions change. It is also important to distinguish between cash and derivative markets, which often offset each other. Finally, avoid getting spooked by flows alone, especially when there is heavy selling or buying. There is often not much substance to statements about record selling or record buying. Always put the number in context – what is the size of the market, what have flows been like on average, and what is the overall trend. Remember too that institutional investors often get it wrong, and have less flexibility than retail investors.
The most important use of institutional information is as a barometer of the market. It provides helpful context, but should not dictate your investing. You still need to decide what you want to achieve, and how much risk you are willing to take, based on your personal circumstances. Maintain a diversified portfolio of stocks, and consider rupee cost averaging to reduce risk. You can also set an asset allocation framework for yourself that tells you how much to invest in debt, how much in equities, and when to rebalance. A SEBI-registered investment adviser can help you create a suitable plan based on your risk profile. This article is for information purposes only, and should not be construed as advice to buy or sell any security.
