-- Published: Monday, 17 November 2014 | Print | Disqus
By Manish Thatte
Lately I have been wondering as to why the stock market has climbed to such heights, especially banking stocks and IT stocks...when there is no real reason for them to be traded in such an expensive price range. And who can afford to buy such expensive stocks (in terms of price to earnings ratio and other fundamentals).
Then I read in the financial newspapers and websites, that DII and FII have been buying Indian equity …Actually, institutional investors have been mopping up financial instruments all over the world.
Who are the DIIs and FIIs?
FII are foreign mutual funds, sovereign funds, foreign pension and provident funds, venture capital funds, hedge funds, foreign insurance companies, foreign registered banks etc.
DII are the domestic or local institutional investors.
These are all managed by professional fund managers with a high pedigree, blue chip education and exhaustive experiences. They can also employ automatic algorithms to buy or sell preset quantities of shares at preset prices.
How do they operate?
The Elephant in the swimming pool: Imagine you and me taking a dive in the swimming pool AND a fully grown elephant comes splashing into the swimming pool. That’s the exact difference between the little guy investing his savings into the stock market and the FII investing in the stock market. When the elephant enters the pool of the stock market, the whole liquidity of the market appears to increase many fold, and conversely when the elephant leaves the stock market, liquidity appears to dry up. The other elephant is the Domestic Institutional Investors (DII). FII and DII have similar strengths, weaknesses, opportunities and threats.
Effects on the stock markets during:
Booms: During boom times, when the institutional investors enter the market, they add to the already high price levels thus inflating the already inflated bubble even more.
Bust: During periods of busting of the stock market bubble, the institutions soak up the already scarce liquidity in the market, thus deflating the bubble to an even greater extend.
Why do the FII and DII always tend to lose money?
Well, the strength becomes the weakness. They cannot enter or leave the market without influencing the behavior of the markets. (Think Heisenberg's uncertainty principle). Because they need to operate at such high volumes, their size becomes a hindrance in their being nimble footed. So, whenever they enter the market, they tend to influence the prices to soar and when they leave the market (i.e. sell stocks), they tend to depress the prices.
Hot money: There is one more problem that the institutional investors cause (especially the FIIs). That problem is felt especially during busts or times of uncertainty. The little guy will always think twice before exiting the market sustaining a loss. But the institutions have no qualms exiting the market even if the capital has appreciated even a little or even has been eroded (They are professionals after all). During times of uncertainty or even due to some remote global event, e.g. raising of the official interest rates by the American Federal Reserve, or a global commodities boom, the FIIs will rush to exit the global stock markets, thus causing a crash in the share prices, even though the market fundamentals are very sound.
Thus the true picture about the health of the economy may get distorted due to the operation of the institutional investors.
Advice: Always go for good value stocks (good order book, P/E ratio, liquidity, managements etc.) and don’t let the market momentum overly influence your investing decisions.
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-- Published: Monday, 17 November 2014 | E-Mail | Print | Source: GoldSeek.com