Stock Market Volatility and Foreign Portfolio investors (FIP) role By Dr. Bobby Srinivasan and Dr. Sudhakar Balachandran

October 23, 2015 | Posted by bobbysrinivasan << back to blog

When there appears a huge volatility in the Indian Sensex index, a question arises in the interested stake holders as to who is responsible for it. Before we address this question, we need to familiarize ourselves with a host of factors that could play a critical role in to-day’s market fluctuation. To start with is the method of trading, according to the data available 43% of all trades executed in the Sensex market is through the algor method. Basically this method is based upon a set of decision making rules whether to buy or to sell which are placed in the order executing process and gets triggered when those rules are met. Then when the data gives a buy or a sell signal, the computer works at an astonishing speed to get these orders executed. In this process the prices of shares increase or tumble in values by a large amounts within a span of few minutes. This drives the retail investor to panic and ends up taking hurried decision. This is a conversation between a student and his professor about this volatility.

Student: Professor, I read in the papers that the FPI own about 21% of all outstanding stocks (by market capitalization) on the NSE, while the domestic investors (both institutional and retail) own 19%. Also this 19% consists of insurance companies amounting to (5%), mutual funds (5%) and the retail investors (9%). The promoters hold 47% and the residual 13% is with companies, NRIs and others. Will these percentages change and if so what would be its impact on the market price discovery process.

Professor: You have almost answered the question. First the promoters are infrequent sellers. They need to follow procedures before they are approved to sell by the SEBI. So basically it is a game between the FPI, insurance companies, the mutual funds and the retail investor. The first person to drop out or reduce exposure is the retail investor since his risk aversion is very high. Besides be brings in very limited amounts of money. From the data one can see that FPI is the dominant player. When they decide to buy, for example, the market index will shoot up and vice versa. Since every buyer is matched with a seller, when FPI sells and if the other stake holders do not buy the market will move crashing down. FPI set the trend in 2009 they sold heavily during the sub-prime crisis and our index dropped from 21000 to 8000. They could do that again and again as their decision making may not only about the Indian market alone. It is clearly a tough game for a retail investor. He is so poorly informed (tell him market is efficient) and so his actions are not data supported but through guts and intuitive feeling. Our Sensex is a pawn in the hands of FPI. They bring in money and buy stocks. Their action leads to capital gains. They can sell and repatriate funds back to their country of origin. The sad part is that they bring in limited foreign exchange but when they take out; they take away lots of foreign exchange which India finds it harder to earn through net exports. As per the current data, FPI market capitalisation is worth Rs. 19.2 trillion rupees (Approx. US $ 306 billion), but most of it is capital gain and not the money they brought in. Summarizing, as long as the FPIs are in the market, we are likely to face big volatility in the Sensex index.

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