In the first of a three-part series we saw how FIIs investment crests near market peaks. In this second part we look at how FIIs, like retail investors, chase prices up and down
We pointed our yesterday that the maximum investments by FIIs (foreign institutional investors) came when the index levels were near their peaks. In most cases, after the FIIs have rushed in with massive investments, the subsequent performance of indices has been below average. The peak of 2010 November has still not been surpassed while the two months prior to that witnessed the largest two-month burst of FII investment ever. The large investment after the market index has run up a lot is a sign of what is called performance-chasing or momentum-chasing.
This happens after the market has turned around and run up against the prevailing wisdom. Investors who were out of the market suddenly feel left out. Institutional investors have a bigger problem. They are held accountable for performance vis-à-vis a popular market index like the Sensex or Nifty. When these indices take off, they feel compelled to chase these indices so that their performance does not suffer. This is why not only have the largest monthly FII investments have been timed with medium-term market peaks, but many large monthly investments have also come well after the market bottoms, trying to play catch up with the rally. The opposite of momentum-chasing happens when the market is sliding. At those times, momentum-chasing takes the form of selling.
Here is some data of both kinds. In October 2008, it seemed that the world would come to an end, as the global financial crisis reached its climax. Investors were shell-shocked at the ferocity with which the market had declined in a few months. For months thereafter the aftershocks were visible. FIIs were selling almost every month, quite understandably, because they were unsure of the future. However, almost all global markets made a low in early March 2009 and embarked on a massive rally. FIIs, who like retail investors, avidly watch prices (formed by millions of others) to decide what they should be doing, were net sellers even in March 2009. By April the Sensex was over 11,400, from over 9,700 in March. Did they see a train pulling out of the station?
In April 2009, FIIs invested Rs5,560 crore, an average month, by their normal standards. In the third week of May, the Congress-led government came to power, which made the Sensex shoot up to over 14,600 by the end of May. The train seemed to be certainly leaving the station now and the FIIs couldn’t miss it at any cost. They invested almost Rs14,000 crore that month—well after the Sensex was up from March 2009 lows and exactly timed with the sudden market momentum. In September 2009, as the market trended higher, they invested over Rs13,3000 crore. But chasing momentum irrespective of valuation levels can often be disastrous. The very next month of this huge investment, the Sensex promptly fell below 16,000.
Evidence of performance- or momentum-chasing is pervasive. In August 2011, the Sensex was around 18,200 when the Eurozone crisis erupted. The market fell and the FIIs turned sellers. As the market headed lower they were not buying. They were selling in a market that was already low. In November and December 2011 when the index was at around 16,000 FIIs were net sellers after turning marginal buyers in October. But when the market picked up in January 2012, the upward shift in momentum had FIIs scrambling to be net buyers, leading to the mother of performance chasing—the market peak in February 2012 when they put in their highest monthly investment ever—Rs23,236 crore. By May 2012, when the Sensex was down below 16,000, FIIs were selling!
The best examples of momentum-chasing can be found in a rising market. When the market declines, FIIs usually stop buying. When it hits 52-week or multi-year lows, they sell. This is what happened in May 2010. As the Sensex headed towards 16,000 from over 17,500 the previous month, FIIs pressed net sales of a huge Rs12,071 crore worth of stocks.
Retail investors jump in at the peak, buy when the market has run up and sell when the market has fallen a lot. FIIs seem to be prey to a similar behavioural pattern. They also do one other thing that retail investors do—panic selling during a severe market decline. We will look at that in the third and last instalment of this series.
Also read: Do FIIs buy high and sell low – I? Maximum buying at peak index levels