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There have been many instances of domestic institutional investors pouring money into stock markets at a time when FIIs are rushing for the exit. A unique Moneylife study reveals that such startling calls of DIIs have been highly accurate
It is no secret that the fortunes of the Indian stock markets are mostly driven by interest from foreign institutional investors (FIIs), who invest in hordes for a certain duration and are as quick on the trigger when it comes to pulling out of the markets. As such, Indian stock markets are frequently left at the mercy of the FIIs, who tend to exhibit drastic shifts in behaviour. But does that mean that FIIs take accurate calls on the markets when compared to their domestic counterparts?
Moneylife carried out a study to identify the behaviour patterns of both FIIs and DIIs (domestic institutional investors) at any given point of time between 2 April 2007 and 25 June 2010. The results were startling. We found that, during this period, there have been several instances when domestic investors have poured in money by the buckets into the markets at a time when FII interest was waning dramatically. Has this contrarian behaviour done any good for DIIs?
Our study has shown that there have been 23 instances when DIIs have stepped in to buy when the FIIs were eager to jump the ship. Out of these 23 occasions, the Sensex has posted negative growth 19 times when FIIs were continuously withdrawing from the market, proving their superior firepower. For instance, during the period between 12 May 2010 and 27 May 2010, FIIs were net sellers on each trading day while DIIs turned out to be net buyers on all these days.
During this period, the Sensex fell by 3%. The index has registered positive growth only on four occasions in such times. This means that DIIs have been investing in a falling market, trying to take advantage of a reduction in valuations and FIIs were dumping stocks. Has this strategy helped the DIIs? We tried to establish the Sensex performance on the seventh trading date after the last recorded buying by the DIIs. It is interesting to note that out of the 19 occasions when the Sensex has recorded a fall, it has gone on to record a positive jump on 12 occasions after the seventh trading day. The subsequent days brought even more gains.
On many occasions, the patience shown by DIIs has paid rich dividends for them. Between 6 July 2009 and 13 July 2009, when the Sensex shrank by 5% due to FII outflows, it went on to post 11% growth after the seventh trading day, 22 July 2009. Similarly, between 14 August 2009 and 20 August 2009, the Sensex had fallen by 3%. But by 31 August 2009, the Sensex had gained 4%. Out of the four occasions when the Sensex has actually remained positive during a period of FII outflow, it has continued its positive momentum until the seventh trading day on two occasions. The decline into which DIIs were buying proved short-lived.
So, next time you find a stretch when the FIIs have been selling continuously and DIIs buying you know what to do.
At this point in the business cycle, emerging market debt looks very attractive, but the lesson of the recent crash is that no investment is free from risk
Emerging market debt. Quite recently the idea seemed to involve quite a bit of risk. After all, investments in debt or fixed income investments are supposed to be conservative investments without either the risk or the volatility of equities. Emerging markets are supposed to involve a great deal of volatility, currency, and political risk. How could they become so respectable? One word: Greece.
In contrast to Greece, the balance sheets of many emerging markets look quite strong. While both Italy and Japan have debt to GDP ratios above 100%, almost 200% in the case of Japan, the debt of Brazil, Turkey, Mexico, Poland and even South Africa are below 50%. Tony Crescenzi of PIMCO put it very simply, “investors are asking themselves, ‘Would I rather lend money to nations whose debt burden is worsening, or to nations where it is improving?’ ”
Not only are the balance sheets often stronger, the yields are as well. For 10-year bonds, the bid price for Mexico is 3.95%, for Brazil it is 4.19%. Ten-year bonds in the US are yielding only 2.43% and Japan’s 10-year JGB yield is only 0.62%.
But what are the risks? First there is the currency risk. In the past unstable emerging market economies produced high inflation and volatile currencies. Often they would borrow in dollars, which caused a crisis if their currencies fell. Today the situation may be reversed. The credit ratings of many emerging markets are good enough to allow them to borrow in their own currencies.
The currency risks have also changed. Much has been written about the undervalued renminbi, it is not alone. The Economist’s most recent Big Mac index, a measure of currency valuations according to purchasing power parity, showed that several emerging markets including Mexico and Indonesia have substantially undervalued currencies. So if anything there is the potential for currency appreciation.
Inflation has always been a headache for emerging markets. Governments would often follow unsustainable development and social programs financed by international borrowing and printing money. Again it appears that the situation is reversed, as central banks in developed countries follow extraordinary loose monetary policies to avoid a nasty recession. Emerging market central banks have looked positively responsible in contrast although inflation numbers in China, Brazil and India are causing concern.
But there are other risks including trying to determine the risk. The Greek crisis was certainly exacerbated by dodgy accounting. According to Pierre Cailleteau of Moody’s, a rating agency, “The state of public-finance accounting is extremely rudimentary relative to private-sector accounting.” Greece is subject to EU rules, has a democratic government and a free press. Legal institutions that allow for access to accurate information simply do not exist in many emerging markets, so the optimistic numbers may only give the illusion of solvency. The reality may be quite different.
It is not only information about governments that creates risk in emerging markets. It is the governments themselves. In developed markets, according to a recent study, increased government interference in the economy resulted in less efficient use of resources. For each percentage-point increase in the share of GDP devoted to government spending, growth was reduced by 0.12%-0.13% a year.
Emerging markets like India, China and Russia are dominated by the government. In all of these countries the government sector is over 50% of the economy. So the present fiscal situation could change rapidly.
In fact it is already changing. Due to the demand, emerging market corporate and sovereign bonds have been issued at a record pace. They are 10% above 2009, itself a record year. This new debt may cause problems because of the nature of debt itself.
In game theory a debtor’s best move is to not pay back the creditor. Debtors do so for only two reasons: the law and reputation. An enforced law can require a debtor to repay. Without law, creditors must rely on reputation. If debtors get a bad reputation then they cannot borrow in the future.
The problem with sovereign debt is that governments make the law, so collecting from defaulters like Argentina has been exceptionally difficult. Usually some sort of structured settlement is necessary similar to what is taking place with Dubai World.
Private companies are worse. The Guangdong International Trust and Investment Corp (GITIC) in China returned probably less than 2% to its creditors. More recently, the creditors of Asia Aluminum also in China may have to wait a long time to see anything. Despite these risks, emerging market corporate borrowing now makes up about three-quarters of emerging market bond issuance, up from just over half before the financial crisis. Ominously the issuers are led by Chinese companies.
Investors want a return on their investments, but it is more important that they get their investments returned. At this point in the business cycle, emerging market debt looks very attractive, but the lesson of the recent crash is that no investment is free from risk.