Why DII Buys to Neutralise the FII Outflows?

The Indian market has exhibited considerable strength over the past few years and has managed to show quick recovery from sharp corrections driven by the selling of stocks by Foreign Institutional Investors (FII). The principal reason for this is the contrarian buying patterns exhibited by Domestic Institutional Investors (DIIs).

When the FIIs turn to net sellers and withdraw funds from Indian markets, the DIIs make adequate purchases, which weakens the FIIs' selling pressure in the markets and mitigates market crashes. Here, we will explore the key determinants of the DII purchases triggered by FII outflowing their investment.

Understanding the roles of FIIs and DIIs

To understand why DII buys during FIIs' outflows, one needs to understand first who FIIs and DIIs are:

​Foreign Institutional Investors (FIIs): Foreign Institutional Investors are investment entities that are non-residents of India and invest in Indian financial sector assets, such as equity, debt, and derivatives. These organisations include asset management companies, pension funds, hedge funds, and sovereign wealth funds. FII data are highly sensitive to global economic factors such as changes in US interest rates and global events such as political unrest, and their outflows can lead to drastic price movements in the Indian stock markets and currency exchange rates.

Historically, FIIs have been a fundamental source of capital for Indian markets, especially after the easing of regulations and market reforms in India in the 1990s. ​Their activities can cause large inflows or outflows in short periods of time, impacting market volatility, index declines, and the depreciation of the Indian rupee.

​Domestic Institutional Investors (DIIs): They are investment institutions headquartered in India, backed by local capital from Indian institutions and private investors. ​These comprise banks, insurance providers, pension funds, and Indian Mutual Funds. ​Unlike FII, DIIs are less sensitive to global news and are more focused on long-term growth and stability. ​

They are important players in balancing market stability by often stepping in to buy when FIIs are selling off. ​The consistent DII purchases are indicative of their strong belief in India's underlying economic strengths. DIIs' investments have a positive impact on retail investor sentiment.

Why do DIIs step in when FII outflows?

When FII investment outflows, the DIIs' investments counterbalance it. This buying behaviour of DII can be evaluated with the help of analysis tools like the Nifty 50 heatmap. There are several factors that are responsible for DIIs neutralising the FII outflows. Some of them are:

Long-term investment horizon

Unlike FIIs, which may be more sensitive to short-term trends across the globe, DIIs, especially mutual funds and insurance companies, operate keeping in view the longer-term perspective. They invest for retirement, education, and other long-term financial goals of Indian citizens. This allows them to look beyond market volatility in the short term and rely on the fundamental strengths of Indian companies.

Systematic investment flows

The thriving SIP culture in the Indian market ensures a consistent stream of funds into the DIIs, irrespective of the market conditions. When the FIIs are selling out in the markets, the DIIs have access to a fresh stream of funds, which allows them to purchase quality stocks at lower stock prices in the markets.

Deep understanding of domestic fundamentals

DIIs have an innate advantage in better understanding the Indian economy, corporate governance, and sector-specific opportunities. They are less influenced by global narratives and more concerned with domestic drivers of growth, policy reforms, and corporate earnings in India. This local knowledge enables them to spot intrinsic value even when foreign investors are exiting the Indian financial market.

Valuation opportunities

Outflows of FIIs often lead to corrections in stock prices, and hence they make valuations more attractive for DIIs. As value-conscious investors, DIIs see these corrections as attractive opportunities to acquire fundamentally strong companies at discounted prices. This opportunistic buying helps them to stabilise their stock prices and prevents panic selling.

Mandate for domestic investment

Many DIIs, especially pension funds and insurance companies, have mandates to invest a certain portion of their corpus in domestic equities. This regulatory framework ensures a baseline level of domestic demand, which is a constant support for the market.

Portfolio Rebalancing

As the selling by FIIs brings down the stock prices, the DIIs rebalance their portfolio by increasing their purchases of equities and thus reducing their average acquisition cost. By acquiring quality stocks during corrections triggered by FIIs, they position their portfolio for superior returns in the long run.

Looking Ahead

The rising investments made by the DIIs during the FIIs’ outflows signal the emerging maturity level in the Indian financial market. This also reduces the dependence on foreign investment in the Indian financial market. Although the influx of investments from FIIs is welcome, the major role played by the DIIs ensures that the Indian equity market has a strong inbuilt guidance system.

At the same time, this trend also highlights the financial understanding of the Indian retail investors, who are choosing to invest through institutional means, as opposed to individual stock picking. There is higher transparency and government regulation over the DIIs’ investments, which gives them a relatively safer means of building wealth.

The presence of resultant buying by the DIIs to counteract the selling pressure from the FII is often evident in the BSE bulk deals, where DIIs as buyers regularly emerge during the broader market weakness caused by FII exits. These transactions reflect the confidence and strategic positioning of domestic institutions in Indian financial markets.

Conclusion

The role of the DIIs as the cushioning factor for the FII outflows is the pivot of stability in the Indian equity market. ​It is an indicator of the increased self-reliance and internal source of funds in the Indian market. As the Indian economy is on its path to progress, the role of the DIIs in cushioning the external shocks and fostering long-term growth of the markets has become more significant.

This is a clear indication of the vibrancy and resilience that exists within the Indian financial market and its inherent ability to navigate the many challenges that come with globalisation.

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