Why stock prices are holding up despite FIIs selling

Outside the Eco-Chamber

Foreign institutional investors (FIIs) have been selling out of Indian stocks since the beginning of September. In September, the FIIs net sold stocks worth Rs 14,768 crore. In October, they sold stocks worth Rs 11,194 crore (up to October 19). In total, they have sold stocks worth Rs 25,962 crore, or $3.12 billion, since the beginning of September.

The FIIs have been selling out primarily because interest rates in the United States have been going up. Given this, higher returns are now available in the US than was the case in the past, leading to FII money leaving India.

But these sales have barely impacted the stock market as a whole. The 30-share BSE Sensex, India’s most popular stock market index, has gone up by around 1.2 per cent during this period of relentless selling by the FIIs. The much broader NSE Nifty 50 has gone up by around 1.9 per cent during the period. The small-cap stocks -- those stocks that rank beyond the top 250 in terms of market capitalisation -- have done even better, with the BSE SmallCap Index gaining 3.6 per cent during the period.

So, what is happening here? While FIIs have been selling, as is often the case, the domestic institutional investors (DIIs) have been buying. DIIs are basically firms like mutual funds, insurance companies, pension and provident funds, banks, etc. Much of the money they invest is handed over to them by retail investors. In September, DIIs net bought stocks worth Rs 20,313 crore. This buying has continued in October, with DIIs buying stocks worth Rs 15,023 crore (up to October 19). This buying, worth Rs 35,336 crore, has more than neutralised the selling by FIIs and, in the process, the stock market has continued to remain stable.

Basically, the retail investors who hand over money to the DIIs are keeping the Indian stock market strong. There are other data points that buttress this point as well. The flows into mutual funds through the systematic investment plan (SIP) route peaked at Rs 16,042 crore in September. A bulk of money invested through SIPs goes into equity mutual funds, which in turn buy stocks. Also, the growth in the number of demat accounts being opened continues unabated, with 3.1 million demat accounts opened in September. Demat accounts are required for buying and selling stocks.

So, it’s the retail investors who have kept the Indian stock market pumped up. Now, there are a few points that need to be made here. Retail investors come swarming into the stock market once prices have rallied and, in the process, send prices soaring further.

Take the case of the small-cap stocks, which have been quite a rage through this financial year. From the end of March to the end of May, the BSE SmallCap Index rallied more than 13 per cent. This ensured that from June to September, Rs 16,586 crore was invested in small-cap mutual funds. This has fuelled a bigger rally in small-cap stocks. They have rallied more than 26 per cent from the end of May to October 19. Small-cap stocks have the highest risk among different categories of stocks.

In fact, there has also been a trend of investors taking money out of the much safer large-cap mutual funds and investing it in small-cap mutual funds. Large-cap stocks are stocks ranked in the top 100 on the basis of market capitalisation. Clearly, investors are chasing much higher risk.

Also, Indian equity mutual funds (EMFs) face a problem of depth. As Vashistha Iyer of the investment firm Capitalmind recently tweeted, 95 per cent of the money of 427 active EMFs was invested in 382 stocks, with 80 per cent being invested in just 178 stocks. So, when money keeps flowing into EMFs, it forces fund managers to keep buying stocks, which drives up their prices further. This might lead to a situation where stock prices get overvalued and do not reflect the future earnings potential of the companies they represent.

So, as and when stock prices correct themselves, the retail investors tend to face losses or make small gains, given that they usually end up buying when prices are on the higher side. Also, most retail investors look at stocks as short-term investment. In fact, data as of June 30, 2023, shows that a little over half of the money invested by retail investors in stocks through the mutual fund route stays invested for a period of just over two years. Most money made by investing in stocks is made by holding on to the investment for the long-term. And two years isn’t exactly that.

The larger point here is that retail investors should be careful and not chase stocks just because prices have been going up. Better be safe now than sorry later.