FPIs or MFs Whom should you follow?

Foreign portfolio investors (FPIs) have always been credited with — or blamed — for market ups and downs. This assumption is not unfounded, given that as a group, they hold the highest stake in the market after the promoters. Therefore, it should logically follow that taking cues from foreign investors should help you pick the winners and cull the duds.

Well, not quite. Aping FPI activity works to your advantage in spotting the potential losers. In order to snag market winners, your odds are better if you look into what mutual funds (MFs) have done over the past few quarters.

These are the lessons from an analysis of the shareholding patterns of the CNX 500 universe over the past seven years. Going by this data, MFs managed to pick more market outperformers than FPIs did. On the other hand, FPIs were more astute in selling market underperformers than mutual funds.

Divergent strategies It’s institutional investors — whether foreign or domestic — that churn their holding the most and by significant margins as well. They also hold a large chunk of the free-float market capitalisation and by virtue of this, their moves sway the markets.

Therefore, their moves are good indicators of whether or not a stock is worth pursuing. A steady rise in the stake of these investors, for two quarters or more, usually signals good growth potential. Similarly, a reduction in stake could mean that the stock’s run can halt. This is true especially in stocks with higher FPI holding.

Considering the December 2014 shareholding pattern, FPIs held around 43 per cent of the free-float market capitalisation of the CNX 500, followed by insurance companies at 10 per cent and then mutual funds at 8 per cent. Though both mutual funds and insurance companies fall into the domestic institutional investor category, mutual funds are more active than insurance companies. The stock-picking skills of MFs have always been better than insurance companies. Looking into what MFs and FPIs do will, therefore, suffice.

Comparing the moves of MFs with that of FPIs reveals that the two groups do not share the same taste in stocks, and even, at times, sectors. Take, for instance, 2008 when the global turmoil sent the markets crashing. While foreign investors cut their holdings sharply in pharmaceuticals and banks, MFs bought into these sectors. MFs built up holding in several agri-based stocks that year even as FPIs sold stake there.

Even where sector preferences matched, more often than not, the stocks preferred (or discarded) in the sector by the two groups overlap only slightly. Consider the auto ancillaries sector, where both funds and FPIs showed continued interest over the years. But to ride the fortunes in this sector, while funds bought into stocks such as Bharat Forge, Wheels India, SKF India and FAG Bearings and reduced holding in Amara Raja Batteries, Apollo Tyres and Motherson Sumi, FPIs did the exact opposite.

Similarly, engineering and industrial sector stocks suddenly found themselves back in favour in 2014. Here too, stocks such as Crompton Greaves, Praj Industries and Jyoti Structure saw a sharp rise in MF holdings. FPIs, instead, preferred BEML, KEC International and Engineers India.

Choosing the winners This stark divergence in stock and sector choices makes it all the more interesting to look into who managed to beat the market better.

To judge the consistency in stock-picking abilities, the stocks in which FPIs and mutual funds hiked and pared stakes were first separated for each year. The returns these stocks made for that year were then measured against that of the broad market.

Years such as 2011 and 2012 were marked by a general uptrend or downtrend, while 2010 and 2013 were largely sideways. A year-wise analysis of shareholding patterns and returns, therefore, reflects the trend over market cycles.

Of the seven years between 2008 and 2014, mutual funds picked more winners than FPIs did in all the years barring one — the sideways market of 2013. This indicates a reasonable degree of consistency in MFs’ ability to buy more into stocks that would do well.

Take the year 2012, for instance, when the broad market gauge CNX 500 index gained 34 per cent. Of the stocks where MFs hiked holding, nearly three-quarters posted returns that beat the market. This compares favourably with the 66 per cent of the 158 stocks in which FPIs raised their holding, managing to do better than the market. In 2012, mid- and small-cap stocks shot ahead of bluechips. MFs used this trend to better advantage than FPIs. Almost all stocks where they raised holding were in the mid and small-cap zone — a fifth of this lot even sported market capitalisations of less than ₹1,000 crore. Additions to Wheels India, Ramco Cements, Shree Cement and Shriram City Union Finance paid off in spades, more than doubling over the year.

FPIs, on the other hand, had a much larger share of sedate large-cap stocks in their preferred list with choices such as Tata Power, Infosys and GSK Pharma failing to light up the markets as much.

MFs lost out in the wandering 2013 market as they took a cautious stance and stayed on the sidelines. They raised stakes in just 56 stocks, compared with the hefty 164 stocks in which FPIs raised their holdings. They were, therefore, a little late to the party that kicked off in August of that year.

But they quickly made up this delay in the strong rally that followed and returned to their norm of going one up on FPIs. Over 2014, MFs increased stakes by a percentage point or more in around 133 stocks in the CNX 500.

Of these, almost seven in every 10 stocks beat the broader market’s 46 per cent return. The average return of stocks where they raised holding was 107 per cent.

FPIs raised holdings in 139 stocks, of which less than 60 per cent returned more than the CNX 500 in 2014.

The average return of stocks where they raised stake was also lower at 99 per cent.

For MFs, several stocks where they hiked holding by a solid margin of 5 percentage points or more belonged to sectors such as logistics, engineering and infrastructure. On hopes of revival in growth, coupled with reforms, these sectors soared.

ITD Cementation, for instance, saw MF holding rise to 23 per cent from almost zero through 2014 with fund houses such as SBI, HDFC and UTI significantly upping holdings. The stock has multiplied almost five times over 2014. Similarly, a swift increase in stake in Gateway Distriparks from 9.4 to 22.6 per cent through 2014 saw MFs gain much from the stock’s 200-plus per cent return.

FPIs lost out by showing more interest in consumer-oriented stocks such as retailing and media, and telecom which have had a relatively slower run compared with the cyclical sectors. For example, in Reliance Communications, FPIs bumped up stake from 11 to 22.5 per cent in 2014, among the biggest jumps in shareholding.

The stock lost 52 per cent from the start of 2014 to date. FPIs also raised holding in Jagran Prakashan, PVR and Zee Entertainment, all of which either just about matched the broader market in returns, or were below it.

The trend of MFs being more likely to add to stocks that go on to beat the market is evident in most other years since the rout of 2008.

Eschewing the losers But FPIs score when it comes to weeding out underperformers. For every year since 2008, most stocks in which FPIs shed stake did much worse than the broader market. This is probably because FPIs pulling out of a stock has a disproportionate impact on prices than when they buy into one.

For MFs, stocks where they reduced their stake still went on to do well. So, if the stock sees a consistent dip in FPI holding, you’re probably better off booking some profit in it.

In the mostly down-trending market of 2011, for example, the CNX 500 index lost 27 per cent. FPIs reduced holdings in almost a quarter of the index’s stocks. And 80 per cent of these declined well over 27 per cent in that year. Those such as GVK Power, IVRCL, Aurobindo Pharma, and Indiabulls Real Estate, which saw FPIs pare holdings by at least 10 percentage points, lost over 60 per cent.

The average decline of the stocks where FPIs reduced stake was 45 per cent for the year.

MFs too cut down their stakes in close to a quarter of the stocks forming the index. But a good 40 per cent of the stocks they shunned actually beat the market.

In Kaveri Seed Company, for instance, MF holding dropped 3 percentage points through 2011 even as the stock rose 25 per cent. They reduced stake in Titan Company by 4 percentage points but the stock slipped only 5 per cent. On an average, stocks which saw a drop in MF holding declined 35 per cent.

In the largely listless market that prevailed for most of 2013, the CNX 500 index went nowhere, ending the year on a flat note. FPIs reduced their holdings in nearly a fifth of the CNX 500 basket over the year. And eight in every 10 of these saw their prices fall. For stocks which saw mutual funds reducing holdings, just about six in every 10 actually saw prices fall. The same trend works out in other market cycles too.

In a nutshell, to make the most use of institutional expertise, buy into stocks where mutual funds have increased their holdings over the past few quarters. Their tendency to take relatively longer term view on stocks than FPIs, lower churning and less volatile holdings work as good guidelines. But if FPI shareholding is falling in a stock, it’s best to stay away as chances are these stocks will fall.

Also read: FPIs have larger slice of the pie