Index Returns and Institutional Trading

Abstract

It is acknowledged that only 2% of the Indian public invest in stock markets. This compares with 55% in the USA and about 25% in the EU. The Indian public is therefore a miniscule proportion of investors and the power of the Indian public to move markets is negligible.
This means that most trading activity in Indian stock markets are by institutional investors consisting of Foreign Institutional Investors (FIIs) and Domestic Institutional Investors (DIIs). It seems reasonable to hypothesize that their trading activities influence market returns.
This paper aims to verify whether this hypothesis can be sustained by analyzing historical data and calculating statistics such as correlations, regression coefficients and coefficients of determination between FII and DII trading activity and Nifty 500 returns. The key aspects that have been evaluated are buying and selling by these institutional investors. Buy/sell ratios of these institutional investors have also been evaluated since buy/sell ratios are a proxy indicator that indicates the strength of bullishness by these institutional investors.
A similar analysis also been done on Mutual Fund trading activity although mutual fund trading activity is normally subsumed under DII trading activity. Since it can be assumed that Mutual Fund trading arises mostly from the ebb and flow of funds from the investing public, they are an important indicator of general public sentiment.
Some significant unexpected results have been obtained as the result of the analysis. For example, it has been found that Domestic Institutional Investor buying has negative impact on Nifty 500 return. This is unexpected since it would normally be assumed that an increase in buying by an important constituency such as Domestic Institutional Investor would likely increase Nifty 500 returns on average.