Foreign funds are no doubt one of the major factors in the bull and bear runs that we see in the markets. Over the last many months we have been seeing them on the selling side while the domestic funds have been buyers. Even as the market kept moving higher their selling continued and one often wondered why. To get some perspectives on this I decided to check the progress of the market using the Dollar designated index- the Dollex and compare its moves with the Sensex. This must have been done earlier by others but I had not looked it and so here is my version.
From the chart, it is clear that the Dollex returns have consistently lagged the returns of the actual Sensex. The chart is from 1992, approximately the start of FII inflow into India. In the years thru till 2008, the returns to the FIIs were commensurate with the returns to the domestic investor, despite being a bit lower in absolute terms. In fact, at the peak of 2007 they actually got slightly better returns compared to the domestic investors. The problems began after the decline of 2008. In the subsequent run up of the market, the Sensex has been quite consistent in its advance, notching up higher tops in 2010 and again in 2015.
Now here is where the Dollex begins to diverge. The peaks in the Dollex in 2010 and 2015 were just marginal improvements on the 2007 peak. This was owing to the sharp weakening of the Rupee or the sharp strengthening of the Dollar (or perhaps both). In the peaks of 2010 and 2015, the domestic investor did far better than the FII investor. The 2010 peak was 9% above the 2008 peak while the 2015 peak was 43% above the 2010 peak for the Sensex. For the Dollex however, the two peaks were actually lower! As a result, the Sensex, by 2015, gained 44% over the 2008 peak while the Dollex actually lost 11% in the same period! This means the domestic investor made a lot of money while his FII compatriot lost a big chunk!
So, does that mean that the FII investor doesn’t make money? That doesn’t seem likely, does it? The trick lies in the timing of the purchases. Matters don’t look as bad as they seem if one measures the gains from end of corrective moves to the subsequent high. For example, the low of the most recent bull market is Aug 2013. The rise from that Aug 2013 low clocked 91% for the sensex while it was 81% for the Dollex- not a significant difference. Going back to the earlier lows of 2008 and 2001 and the subsequent gains made from those lows, we find that the returns to the FII were actually higher compared to the domestic investor!
So, it appears that peak to peak, the FIIs have been losers (and big time) while in gains from the lows, their returns have been in line with the domestic investor. Since we have found that FII investors are pretty savvy at the time of the turn of the trend from the lows, it can be presumed that they do indeed manage to get in some decent returns by being first off the block near bottoms. Presumably, that is how they stay in the game and profit!
Moral of the story: Follow the FII when they enter at the bottom but don’t follow them when they are buying near the highs!