When FIIs sold aggressively, on most occasions it would have been a good time to buy. But, only when valuations are reasonable
For the past 22 years, the main players in the Indian markets have been Foreign Institutional Investors (FIIs). They have collectively put in hundreds of billions of dollars in India. When they sell aggressively, the market goes down. Their selling has been severe over late August. A possible slowdown in China hurt investor sentiment world over, resulting in a huge sell-off in equities across the world.
On just one day (24 August 2015) FIIs sold Rs5,142 crore worth of shares. For the month, as much as Rs9,140 crore has been withdrawn by FIIs. This has been the highest outflow since June 2013, when Rs9,300 crore was withdrawn from Indian equities. If buying by FIIs signals good times for the market, surely means selling by FIIs would mean bad times ahead?
“Periods like now where FIIs are selling aggressively are the best times for long-term investing,” suggested Sankaran Naren, chief investment officer, ICICI Prudential Mutual Fund. Moneylife decided to take a look at what happens when FIIs sold aggressively in the past 15 years. We did a simple adjustment: the net inflows and outflows of FIIs in the past years are adjusted to today’s prices, assuming an inflation rate of 7%.
There were 17 occasions when FII outflows were greater than Rs7,000 crore in a single month. Had you invested in any of these months your average return would be 14% over one year and 16% annualised over two years. In the 14 three-year periods after an outflow of Rs7,000 crore, there was not a single period of negative return and an investor would have gained an average return of 11% annualised. But average returns is not what you should focus on.
Taking the market valuations at the time into perspective, the best forward returns have come at a time when the Sensex trailing price-to-earnings was under 20. In October 2008, when FIIs sold as much as Rs22,000 crore, the Sensex PE fell to a low of 12 times. The forward returns were spectacular: 62% over one-year, 22% annualised over three years, and 15% annualised till date.
However, a few months earlier in November 2007, when FIIs sold over Rs7,000 crore, the market PE was as high as 26 times. Investors who jumped in at that time would have been disappointed. The Sensex was reduced to half its value a year later and returned a mere 4% annualised till date. Similarly, in six out of the seven occasions when the Sensex PE was above or equal to 20 times, the returns were negative over a year. Poor returns were seen even over the three year periods. The Sensex delivered single digit annualised returns in all the seven periods when the PE was 20 times or more.
On 24th August, when the market crashed by over 5%, the Sensex PE fell to 20.37 times from around 22 times a week earlier. Now, after the markets have regained some confidence, the Sensex trailing PE increased to 21 times as on 27th August. Going by the limited history of the past 10 years, this may not seem as attractive a time to invest.
In short, investing because FIIs have sold aggressively and expecting the market to deliver good returns may lead to disappointment, especially when valuations are high. Aggressive FII selling gives an opportunity to invest and accumulate, but don’t base your investments solely on FII buying or selling. Those investing for long term goals should continue to invest regularly and look for such buying opportunities, because over the long-term, the market would move higher.
Years ago, ace investor Warren Buffett wrote: “A simple rule dictates my buying: Be fearful when others are greedy, and be greedy when others are fearful.” Wide-spread fear seems to have struck once again, though not as severe. It’s time to accumulate good stocks. As Buffet wrote further in his article, “Let me be clear on one point: I can’t predict the short-term movements of the stock market. I haven’t the faintest idea as to whether stocks will be higher or lower a month — or a year — from now. What is likely, however, is that the market will move higher, perhaps substantially so, well before either sentiment or the economy turns up.”
