Foreign Institutional Investor and Retail Investor in the Indian Stock Market – A têtê – à – têtê – By Dr. Bobby Srinivasan and Dr. Sudhakar Balachandran

Janakiraman (Joe) and Swaminathan (Swami) are first cousins both initially lived in Chennai. Joe went to study in the US and later became a permanent resident while Swami finished his MBA from a top business school in India and took up a job with an MNC in Chennai. Joe is currently on a short visit to India after 2 years and decided to touch base with his cousin to catch up on family and other matters. This is an excerpt of the discussion they had on the Indian stock market. This is how it goes.

Joe:         Swami, it is nice to see Mr. Modi as our Prime Minister. After 10 years of UPA this is a refreshing change. His election triumph has created an euphoria in the Indian stock market. Personally, I am grateful to him as my Indian stock mutual fund has made significant gains in the last 2 weeks. In fact the NAV has gone up by more than 30 percent

Swami: Good for you Joe and hope the momentum is maintained (Swami is unhappy since he missed out this rally. He exited the market six months ago since he was not sure of the election outcome).

Joe:         I hope so. I am planning to increase my investment in the mutual fund when I return home. You see, US market is OK but it is harder to get a stellar performance like this. I am sure you must be equally thrilled about this.

Swami:   To be honest with you. I am not in the market right now and don’t plan to return any time soon.

Joe:         I am surprised to hear this from you. You are closer to the action. All the day to day actions in the market are available to you and why would you not want to participate.

Swami:   You see Joe, unlike you I am a small retail investor and sensitive to price fluctuations. It is said that 80 percent of the retail investor loose money in the market. It is very much true in my case. I learnt a lesson in 2008 during the global stock market meltdown and lost heavily in the market. I know I was vulnerable but couldn’t exit in time. We need the FIIs badly. Without them, our market has very low volume. Next is the domestic institutional investor (DII). They produce products called the unit trust which include stocks from various sectors in the market and sell them to the investment public. The managers of DII are well qualified and experienced and they keep track of the FII investment activities. They generally stay invested over a long haul and so short term fluctuations don’t create any anxiety in them. If the prices go down significantly the excess cash they hold is immediately pumped into the market. Next is of course is the retail investor. He is generally ill informed filled with greed and is willing to listen to any tom, dick and harry and act. His desire is to double his money as quickly as possible. He does not understand the game well and often looses most of his investment during the high volatility period. It’s like this FII’s bring in 100 lakh rupees DII’s bring in 50 lakh rupees and the retail investor brings in Rs. 50000. Retail investor gets butchered because his Rs. 50000 quickly disappears.

Joe:         It sounds funny. What happened to you? Why did you freeze? I thought you     majored in Finance and knew about risk return etc.

Swami:   Yes of course but I need to share important information with you. It is often said that a sucker is born every minute and it is true in the case of the Indian stock market. It is always the retail investor who looses in the end. You see we have three categories of investor in the Indian stock market. First is the foreign institutional investor like your Indian mutual fund. There are 1760 of them registered with the Indian stock exchange. They include pension and hedge funds. They bring in huge amounts of money. As of date they have invested US $ 200 bln in the Indian market which they can take out of any time. Our foreign reserves as of today is about $ 310 billion. When you guys sell out both our currency and stock market go on a tail spin sometimes leading to a major meltdown. Actually 45 percent of all tradeable stocks are in your hands. You are not affected by our taxes and so can decide to exit any time. You are the guys with a privilege of first in first out and so how can you loose. When the market drops say 30 percent during one of the volatile period the retail investor goes berserk and gets out of the market before his capital is wiped out. The winner namely the FII and the DII take this poor souls money. Even if the position is profitable he rushes to take his profit too early. You cannot help but pity him. You see in 2008 there were 1.5 crore of them. The stock market meltdown of 2008 eliminated 50 lakh retail investors. They never returned.

Joe:         Are you then saying that FIIs and DIIs are the winners in this game almost and always

Swami:   You bet it is the case. Let me tell you what happened to me in 2008 during your sub-prime crisis. Believe me. I had no idea about your fico scores and what sub-prime stood far. Also how could I imagine that the Indian market will be hit hard because of your housing crisis. The following data will explain. From Feb 6, 2006 to October15, 2007 (a period of 20 months) the sensex index went up from 10000 to 19000 then reached a peak of 21000 and then crashed. One third of the retail investors got so badly hit that they sold out their holdings for a huge loss promising never to come back again. Please look at the data.

Sensex index

Feb 6, 2006                                 10000

Mar 21, 2006                             11000

Apr 10, 2006                              12000

Oct 30, 2006                               13000

Dec 5, 2006                                 14000

Jul 6, 2007                                   15000

Sep 15, 2007                              16000

Sep 19, 2007                              17000

Oct 5, 2007                                 18000

Oct 15, 2007                               19000

Do you see the upside swing? The downside swing was so rapid that before the denial stage was passed the market had crashed.

Joe:         Swamy thank you. I am a first time investor in the Indian stock market. I was not aware of this. I will keep a careful watch and not take anything for granted.

Swami:   Good you met me this morning. Believe it or not both our currency value against the dollar and the stock market are at your mercy.

Swami:   Let me give you some more gyan.

Point 1: Indian stock markets are not efficient or semi efficient and some such garbage they teach us in the MBA program

Point 2: It is completely driven by the inflow and outflow of money (liquidity). If you guys or a big DII decides to invest, our market will go up substantially. Similarly if you sell out our market index drops like a thud

Point 3: It benefits those who are first to the information and clobbers the one who joins the market at the end.

Point 4: It basically benefits the promoters because of the access to the information about the arrival of funds. The FIIs benefit because of access to some privileged information. Don’t get me wrong. I am not talking about insider trading. Privileged information is nothing but an outcome of complete understanding of the economy as well as the potential government policies and their impact on the market. They know as to when the big chunk of money is coming into the market. The US market moves significantly in 11-12 trading days in a year because of the massive inflow of funds and it is the same in India.

Joe:         Swami with this knowledge I hope you will succeed in the future.

Swami:   Joe I should add something to what I said earlier. I am learning to change my status from being a long term investor to a trader. This way I never stay in the market for more than a couple of weeks any time. At each entry I reassess as to whether to play long or short on the Nifty options and futures. I am currently involved in a small way and I am really happy that things are going in my favor. You see a trader makes money when the market is going up or going down or moving side ways. You see he is always in the game to take advantage.

Joe:         Hope we can meet again before I return. You can teach me about your winning trading strategies. Have a good day.

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