In choppy markets, retail investors often track the buy-and-sell calls of large foreign institutional investors in the hope of generating better returns. But, though the investment patterns of FIIs can provide valuable insights and serve as useful tips for stock picking, blindly following such a strategy can hurt such investors, say ET Intelligence Group''s Jwalit Vyas & Parul Bhatnagar

In ancient times, man searched for the fabled elixir, a legendary potion that was believed to have the power to grant the drinker eternal life or youth. The elixir was also said to be able to create life. A similar search for a life-giving and life-transforming force is on even today in our financial markets where every investor is on a perpetual search for a ?monetary elixir'' that would grant him the power to predict the markets to metamorphose money. However, the secrets to multiplying money remain as elusive for an investor as man''s search for the road to immortality.

In their hunt for cues to multiply cash, a common tendency among retail investors today is to track and imitate large institutional investors. However, ET Intelligence Group''s analysis shows that blindly tracking foreign fund trends could be a dangerous way to take investment calls.

Investment patterns of large investors can no doubt give valuable insights into the market and serve as useful tips for stock-picking. However, institutional investors may not be always right and a prudent retail investor would never blindly follow them.

Between April-June 2009 ? when markets recovered from their lows? and March 2011, foreign funds increased stakes in a host of Indian firms. Had retail investors then followed FIIs to select companies such as Tata Motors, Lupin, Hindalco, Tata Consultancy Services or Bharat Forge, by now they would have doubled or tripled their investment. But had they followed FIIs on stocks such as DLF, IVRCL or GMR Infrastructure they would have lost more than half their capital. Similarly, dumping stocks such as JSW Steel, Gail, Mahindra & Mahindra and Wipro merely on the pretext that they had fallen out of favour with FIIs would have been a costly mistake as all these stocks have outperformed the Sensex by 24-72% over the past two years.

IMPORTANCE OF FIIs

The strategy to follow foreign institutional investors, or FIIs, stems from the fact that their presence in the Indian capital markets has increasingly grown over the past few years. If one plots the FII flow data with the performance of the BSE Sensex, the simultaneous movements of the curves indicate that the linkage is very strong. FIIs have invested $57 billion in the Indian markets over the past five years compared with total market capitalisation of $1,465 billion. Again, considering to a financial muscle of these large investors, their presence could boost the stock valuations substantially.

NOTHING FOOLPROOF

Our study highlighted that FIIs have visibly increased their stake in diverse sectors such as real estate, infrastructure, two-wheelers and pharmaceutical. Also, quite a few of the ?hot picks? of FIIs have shown negative returns during our period of study. For instance, in 2009, FIIs were very bullish on the real estate sector. They still hold more than 72% and 64.5% of the free float in DLF and Unitech, respectively. However, DLF has lost more than 25% of its market value and Unitech more than 54% in the past two years, despite 28% rise in the Sensex.

That is the case with Educomp Solutions, in which FIIs held more than 82% of the free float as of the end of the June 2009 quarter. Still the scrip has grossly underperformed the markets in the past two years. Even after reducing their stake, FIIs still continue to own 71% of the free float in it.

UP AND DOWN

Out of the 60 scrips in which FIIs have increased their stake over the past eight quarters, 23 have underperformed the BSE Sensex. Statistically this may appear acceptable ? just a little above one-third misses.

However, one must consider the low valuations at the time of June 2009 quarter when markets were just recovering from the lows of March 2009.

IVRCL Infra was the biggest loser, underperforming 84% against the Sensex in two years despite FII holding going up to 55.6% from 53.2%. Six other scrips mainly in real estate and infrastructure spaces have underperformed more than 50%.

Similarly, the list of 40 scrips in which FIIs reduced their stake in the past two years holds some gems that have outperformed the Sensex by a wide margin. Be it automobile companies such as Bajaj Auto and M&M, or petroleum PSUs like Indian Oil, BPCL and Gail, the scrips have given positive returns in the past two years, although FIIs preferred to trim their holdings.

ACTION POINTS

While it is true that the FII activity can show where their interest lies, one need not follow them blindly. Just as FIIs raising their stake can''t be a good investment argument, FIIs reducing stake shouldn''t make one jittery, if one has done the homework. We have shortlisted a few stocks based on their these arguments, which we believe can outperform markets in the coming years.

GOING WITH FIIs

FII holding has moved up in Mundra Port and SEZ to 10% from 5% over the past couple of years, although the scrip underperformed the Sensex. The company owns one of India''s private sector ports and is benefiting from a shift in port traffic to Gujarat, thanks to its proximity to the industrial areas in the north.

In addition, the company''s operating profit margins at 69.5% for FY11 are far superior to its peers. The scrip''s current P/E of 28 is lower on historical basis, while in the medium term the company holds healthy growth potential.

This is evident in the case of state-owned Power Grid Corporation, which controls the market for inter-state power transmission. Considering growing domestic demand for power and ageing transmission infrastructure, the company''s importance is going to rise in future as it can supply power from surplus areas to deficient ones. The company enjoys high margins and strong cash flows. Its decision to let out its transmission towers to telecom players can open an additional source of income and improve earnings. The stock trades at a P/E of 19 times and is valued at virtually close to its historical lows.

GOING CONTRA TO FIIs

FIIs might have reduced their stakes in companies such as M&M and Gail over the past two years, but we still find them attractive.

Automobile major M&M, which is expanding its position in personal vehicles and is a leader in tractors segment, is currently trading at a P/E of 15.7% and has seen FIIs trimming their stake to 23% from 25% over the past two years. The company''s various diversifications ? two-wheelers, electric vehicles, yachts, etc ? make it a healthy candidate to outperform in future.

India''s largest natural gas transporter Gail is another scrip where FIIs have pared holdings, but we hold a bullish view. The company is investing heavily in its business to double its transmission capacity over the next two years. This makes the company a beneficiary by default of the rising natural gas demand within the country. It is also expanding in petrochemicals, city gas distribution and upstream E&P business. Ad hoc subsidy burden and stagnating domestic gas production are two key concerns. However, long-term investors need not be weighed down by such concerns.

CONCLUSION

FIIs may identify future growth prospects better than retail investors as they have technical skills and financial strength. However, their call could also go wrong, buying in stocks that underperform or selling out those that outperform. It is difficult for a retail investor to own a portfolio as diversified as that of a large investor. This leaves the investor with little choice but to do his own research before parking his money in a stock.

POSITIVES

Institutional investors have dedicated and highly qualified research teams and typically pick stocks with growth potential ahead of smaller players Large investors typically take a medium to long-term view on equity markets Good for short-term traders, who can participate in the extra liquidity created by entry or exit of FIIs

NEGATIVES

Can lead to a herd mentality and push up valuations. A retail investor might end up buying stocks, which are the current favourites of institutions and at the peak of their historical valuations. Global headwinds could force FIIs to sell local equities, regardless of fundamentals or growth prospects Financial goals of individuals and institutions may not always converge. Buying or selling by a fund could be a part of their hedging, diversification, trading, or buy-and-hold strategy. Retail investors may not be privy to this. The risk profile and investment horizon of big players may vary compared to retail investors.

METHODOLOGY

For this story, we checked the eight quarter FII holding data of the BSE 100 companies between June 2009 and March 2011 quarters. The FII holding was calculated in relation to the free float ? or the equity excluding promoters'' stake ? to make all data comparable. This put companies, where FIIs can''t hold a larger stake due to high promoter holding, at par with those with smaller promoter stake. End-of-quarter prices were used for measuring the stock performance during the period. The stock performance was compared with the corresponding Sensex performance to identify the underperformers.