An important feature of the development of stock market in India in the last 15 years has been the growing participation of Institutional Investors. Institutional investors comprise both foreign institutional investors and the domestic institutions like (mutual funds, insurance companies etc). In India, these institutional investors manage large amount of funds which constitutes a significant share of the entire market capitalization. The role of these investors especially FIIs (also known as foreign portfolio investors) in Indian stock market has been a matter of debate. FII investments seem to have influenced the Indian stock market to a considerable extent. Looking at the direction of the funds flow from these investors, we can explain the market movement.
Why are FIIs important?
Attracting foreign capital appears to be the main reason for opening up of the stock markets for FIIs. In order to attract portfolio investments, it has been advocated to develop stock markets. The general perception about the foreign portfolio investments is that, not only do they expand the demand base of the stock market, but they can also stabilise the market through investor diversification.
Impact on Share price:
Price discovery of stocks are results of the interaction between supply-demand forces. Buying equities in huge chunks leads to a steep rise in the prices and heavy selling leads to a massive fall in the prices. Heavy buy and selling of stocks create a demand-supply gap situation for that particular stock and which ultimately result in the fall or rise in the price. This is what happened when FIIs come into play.
General perception about FIIs that they bring good money and also their entry symbolizes a mature market. Though, it is true that FIIs do help in formation of an efficient market, their sudden movements of funds have been responsible for some of the biggest stock market crash in the history.
Investment by FIIs is heavily dependent on the expected return. Whenever there is a change in the expected return scenario (due to political situation, restrictions etc) or availability of a better investment opportunity, a movement of funds can be seen by these FIIs. This comes through heavy selling of the stock holdings in their portfolio. And due to this heavy selling massive falls in stock prices take place.
Individual investors who jumped into the fray when market was rising feel the pinch most when these FIIs sell off their holdings. These investors incur heavy losses due to the sudden fall. The stocks also take severe beatings as these stocks takes a long time to recover due to loss of confidence, despite the companies’ good financial performance.
Here, we will see the effect of FIIs fund movement on stock prices through the analysis of historical price and shareholding pattern of Vakrangee Software, a domestic mid-cap IT Company.
The Company: Vakrangee Software
Vakrangee Softwares Ltd is a domestic IT company. The company’s businesses include Document Management Services (DMS), Printing Management Services (PMS) and IT & IT Enabled Services (ITes). The company has a good business model and expected to grow with a rapid growth rate in future.
The stock of the company is currently trading at Rs.32. The company’s stock price has fallen from all time high of Rs.291 to Rs. 19 due to heavy sell off by FIIs. The fall of stock price started from September,2008 onwards due to heavy selling by FIIs. Their stake in company has come down to zero in Dec, 2008. The sudden fall in stock price can be seen in historical price chart (between 31/07/09 to 28/11/09).
These two Pi-Charts explain the change in the share holding pattern of the company in last two quarters. Before September quarter, FIIs had a major share (18%) in the company. Their share was almost equals to the promoters share. Now, in December quarter, FIIs share came down to zero due to their sudden exit which led to a massive fall in stock price. Currently, the company is available at a deep discount and with almost no risk. Here no risk implies zero FIIs’ stake in the company.
By the analysis of Vakrangee Software, we can conclude that the companies in which FIIs have very large stake are more prone to have stock price crash than the companies in which FIIs has no or very low stake. Before investing in such companies, investors should always do some research and try to find out whether FIIs are dumping the stocks.
Here the result of this analysis also applies to the whole market. A very large amount of fund under FIIs management without any restrictions on their movements can destabilize the market.
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