FII money is good but need to be alert

It is the continuous inflow of foreign institutional funds that is driving the Indian stock market to a Sehwagian performance, with the Sensex notching up 293 points during the past week to hit an all time high of 6361 before closing at 6322. This is one of the bou"uets of increasing institutionalization of capital markets. Investors ought to be aware of the brickbats, too.
The pool of institutional money invested in li"uid financial assets in the OECD countries, exceeds their combined GDPs! Thus these institutions have enormous clout.The most obvious danger is the what if "uestion; what if the FII flow is stanched or, heaven forbid, reversed? The domestic market is, at the moment, looking overbought and vulnerable to the slightest of shocks.
There are other brickbats as well. The most pernicious of them is the short-termism. Fund managers—whose bonuses are linked to short term performance (with some exceptions, such as Fidelity, which assesses on 3 year performance)—put pressure on corporate managers to take short term views.
Recently, Shell admitted to overstating oil reserves and, as per the Economist (Nov 27), most other oil companies have overstated reserves in order to get a better valuation. Oftentimes executive pay is linked to valuations.
Institutional investors are, by virtue of the size of assets under management, both able and willing to pay higher prices for stocks than individual investors are and can. This explains why there is such a difference (50 per cent or thereabouts) between the ADR prices of companies like Infosys or Wipro, and their domestic prices.
Wipro is reportedly now planning to make a $1bn sponsored ADR issue, to give greater li"uidity to foreign investors, and so bringing down the premium. The issue will be absorbed in no time given Wipro’s record.
For domestic investors this means, that availability of stock for trading is declining. There are buyers with lower return expectations, who are willing to pay higher prices and domestic companies see no reason not to oblige them.
Fortunately, domestic investors do have fresh IPOs coming in, including some attractive PSU divestment stock. NTPC, for instance, had obtained permission from the Government to offer 10 per cent of its e"uity; it offered only 5.25 per cent.
The balance is available, without needing permission from the government, with a slipped disk problem whenever it looks left, for sale. It plans to make, in 2006, an ADR issue. Its stock price is moving up on the same logic of FIIs willing to pay a higher price than FIs. With NTPC accounting for 19 per cent of totaled installed capacity for power generation, and 26 per cent of power generated, it becomes a play on India’s economic performance.
The pool of institutional money sloshing around can also distort demand and send wrong price signals. High oil prices, going over $50/barrel, was a global concern.
Part of this was speculative and not natural demand, with funds betting on the commodity. Last week oil prices collapsed to $42.5, as thespeculative fervour abated, another factor driving up stock prices.
The market appears overbought and one should await a fall before entering. The India story still looks attractive but would be more so if the Government did some back strengthening exercises and took some decisions for the future instead of the present.