FIIs are selling. Mutual funds are buying. Here’s what you should do

Here’s the data as on 12 October 2023:

August 2023 –

Net FII flows – 20,620 cr outflow

Net DII flows – 25,016 cr inflow

September 2023 –

Net FII flows – 26,592 cr outflow

Net DII flows – 20,312 cr inflow

October 2023 (month till date)

Net FII flows – 11,206 cr outflow

Net DII flows – 9,557 cr inflow

Cumulatively, FIIs have sold Indian stocks to the tune of 58,418 crore, while DIIs have bought a net of 54,885 crore.

Now that, dear reader, are some very large numbers. And that too at the opposite end of a view of how Indian stocks could perform in time to come.

Let’s try and unpack some of this. Note, that since we do not know why the FIIs and DIIs do what they do, we can only speculate as to the reasons for their actions.

Start with the FIIs.

The fact that FIIs are selling could be linked to three factors.

First, the risk-free rate in the US is increasingly becoming very attractive. Just by keeping money in the US equivalent of a savings bank account (or a short-term government treasury bill) one could get a 5% annual return. Add on a bit of risk, and one could earn more. Less than two years ago, this was nearly 0%. Then the need to scout the world for a higher return was justified even if it meant taking on more risk. But now, at the margin, that desire to hunt for yield is muted. As a result, money is flowing back to the US, or rather staying back in the home country (suppressing new inflows).

Second, both geopolitically and economically, the world is a lot more uncertain than it was till recently. On the one hand, there are headwinds that could push western countries into a recession (though no one can say for sure). On the other hand, the world seems to be sitting on a tinder box when it comes to geopolitical issues.

Picturise the conflicts that have already flared up or could do so in time to come: Russia-Ukraine, North Korea – South Korea/Japan, China – Taiwan, India – China/Pakistan, Israel – Middle East. And that’s just top of mind. Africa is too going through a phase of unrest. Put all this together, and this part of the world seems not very reassuring. Not surprisingly, money flows are likely to be muted. And some money could flow back to the home country i.e., US. Even other investors find the US to be the best place to “hide” in such situations. It’s often termed a flight to safety.

Third, it could be argued, that Indian stocks have had a stupendous rally in recent years. And it just makes sense to take some money off the table.

There could be other reasons as well, but this is what I believe are key reasons for the relatively large sell off.

Taking this a step forward, a chunk of the selling is forced on account of the relatively attractiveness of investing in the US.

Now, let’s shift focus to the Indian mutual funds. The big bulls of today’s stock markets.

Here I have only one reason to offer.

It’s the surge of retail money flows into mutual funds that’s forcing mutual funds to buy into Indian stocks. Period.

That’s obviously not a great situation. Unless of course, you close the fund off to new money (completely or partially), which some funds have done off late. A tiny minority at best.

Now, there’s one element of the money flows into mutual funds that one needs to focus on. A large chunk of it is coming into small-cap, mid-cap funds, and thematic funds. Look:


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About 60% of the net money inflows in August and September 2023, went into small-cap and midcap funds (or funds with significant allocation to them). That’s huge.

Not surprisingly, an additional 23% of the net inflows went into sectoral/thematic funds. Again, a feature of theme driven bull markets.

So, having laid this groundwork, some things become apparent.

Indian mutual funds are being forced to buy into mid-cap and small cap funds. And “certain” themes like “India opportunities” (never understood this!) and “technology/digital” among many others.

Now, what about FIIs? Well, FIIs are very large investors in India, and typically a large chunk of their investments, I would guesstimate, would be in large caps. So just like mutual funds are being forced to buy, the FIIs are being compelled to sell their India holdings i.e., likely to be significantly large caps. (If FIIs were selling small caps and midcaps, the markets would have felt the impact!).

How can you profit from this dichotomy in views?

Well, to the extent the selling (or lack of buying) is forced on account of factors other than valuations, an interesting opportunity could be to be on the other side of the trade i.e. large caps. You are effectively buying into a fire sale, so to speak. Just be careful what you buy.

On the flip side, you can avoid spaces where mutual funds are making a forced purchase i.e. small caps. Mutual funds have to buy whether they like it or not because the money just keeps coming in!

Simple, right?

Unfortunately, going against the market is a tough ask. Not only do you have to mentally be able to deal with near-term underperformance, but also with the momentum investor brigade who believe there is no other viable investment approach around!

I am, however, sticking with it. No matter what the near-term offers.

What about you?

Rahul Goel is the former CEO of Equitymaster. You can tweet him @rahulgoel477.

You should always consult your personal investment advisor/wealth manager before making any decisions.