The buying and selling activity in stock markets is often driven by a lot of myths. While there is enough literature and anecdotes on the right way to invest and common investing mistakes, we all at some point of time have been victims of certain misconceptions that are widely prevalent. One such myth is that if foreign institutional investors (FIIs) are buying a stock, it must be good.
The recent rally in the Indian stock markets is a lot driven by FII inflows. The Indian equity markets are dancing to the tunes of FII and have taken a break from the economic fundamentals. Infact, the peaks and lows in the Indian markets have coincided with FII buying and selling activity. As per an article in Economic Times, among emerging markets where elections are due, FIIs' allocation to India at 35% stands the highest. It is obvious that this inflow of funds is more of a bet on election outcome than any improvement in the fundamentals of the Indian companies.
Retail investors, often in self doubt mode, may find it hard not to get carried away by FII enthusiasm. A common perception is that FII investment in a particular stock is backed by strong research and has some of the best brains behind the investment decisions. Afterall, they invest in bulk and apparently face higher risk. So does it not make sense to follow what they are doing?
The answer to why aping FIIs does not make sense lies in basics of investing. We all know that investment decisions should be based on an investor's return expectations, risk tolerance and investment horizon. And they are likely to be quite different for retail investors than they are for FIIs.
First, though on an absolute basis, Foreign Institutional Investors (FIIs)investments in a stock may seem huge, it is likely to form a very small percentage of the overall corpus of funds that they deal in. As such, their holding capacity and tolerance to risk varies from that of a retail investor. Hence, while a bad investment decision regarding a particular stock may not hurt FIIs much, the retail investors can end up burning their fingers. Also, the time horizon for FIIs could be very different from that for an individual investor. In such case, FIIs will not be much affected if the price of the stock they hold dips. On the other hand, a retail investor with no deep pockets and in need of liquidity can end up incurring losses on the same.
Further, return expectations for FIIs might be starkly different from that of a retail investor. When the yields in their own markets are low (which has mostly been the case with developed markets), FIIs would be happy to switch to Indian markets and earn relatively better returns. However, for retail investor in India, where returns on fixed deposits are relatively higher, investing in the stocks (in which FIIs are investing) might not justify the risk associated with equity investment.
Often, FIIs inflow or outflow in a particular market is driven more by external reasons such as US tapering, expectation of change in the Government etc. FIIs are quite quick and often the first to make an exit even on the speculations which may or may not be right. No wonder FII funds are often termed as hot money. By the time the retail investors get to know about it, the stock prices have already plummeted and they are left with losses. At the same time, if FIIs are exiting a stock, the reason may not be bad fundamentals, but their need for liquidity. If you end up copying their moves, you might lose on a good investment.
In short, the decision to invest in a particular stock should be driven by bottom up approach and a person's own investment profile such as return requirements, time horizon and risk tolerance. At the most, one may be watchful of FII activity in a stock and may use the knowledge to dig further whether the reasons for them are stock specific or driven by external factors. But by following FII investing activity blindly, you are more likely than not to burn your fingers
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