Foreign Portfolio Investment: Foreign portfolio investors, their types, and the Indian markets
Who are Foreign Portfolio Investors?
You must have often observed while going through your daily news feed, an activity that FPIs carry out and maybe, how the Nifty or the Sensex reacted to this activity by the FPIs.
What exactly is this activity? Who are FPIs? Why would stock market investors worry about this in India?
FPI stands for Foreign Portfolio Investment.
We have Indian nationals investing in the Indian financial markets. However, this does not end here. We have a lot of investors outside India, from other countries, that wish to tap into the enormous growth potential that India possesses, through its financial markets. These are the Foreign Portfolio Investors.
Some of the Foreign Portfolio Investors include:
- Hedge Funds
- Foreign Mutual Funds
- Sovereign Wealth Funds
- Pension Funds
- Trusts
- Asset Management Companies
- Endowments, University Funds, etc.
FPIs are allowed to invest in investment assets like stocks, depository receipts, mutual funds, ETFs, and bonds. When a foreign entity takes ownership of these assets in India, they are then classified as foreign-owned investments in India.
On a high frequency, there is a buying and selling activity by the FPIs in India’s financial markets and analysts often take the nature of this activity as a key indicator of where the Indian economy is headed and how the world is perceiving the Indian financial markets.
Why would investors from a different country invest in the Indian markets?
The reason being, as mentioned earlier, to tap into the enormous growth potential that the Indian economy has. It is generally seen that the countries that see great interest from foreign investors and their active participation are the developing or the emerging market economies.
Regulations for FPIs
Securities and Exchange Board of India (SEBI) is the regulator when it comes to FPIs in India. FPI in India refers to 2 investment groups:
- Foreign Institutional Investors (FIIs)
- Qualified Foreign Investor (QFI)
FPIs have been officially classified by SEBI into 2 categories after certain amendments.
- Category I FPI includes:
- Government and Government related investors
- Pension funds and university funds
- Appropriately regulated entities such as asset management companies, banks, investment managers, investment advisors, portfolio managers;
- Eligible entities from the Financial Action Task Force (FATF) member countries;
2. Category II FPI includes all investors not eligible under Category I such as:
- appropriately regulated funds not eligible as Category-I foreign portfolio investor
- endowments
- charitable organizations
- corporate bodies
- family offices
- Individuals
- Unregulated funds in the form of limited partnerships and trusts
Often there is a lack of clarity between the terms FDI and FPI. FDI stands for Foreign Direct Investment. This, like FPI, is an investment in companies and businesses in India by a foreign entity. However, an FDI differentiates itself from Foreign Portfolio Investment (FPI), as in this case, the foreign entity directly owns and controls the business/company it invests into whereas an FPI does not actively control the company and has no direct control over the assets.
Factors affecting foreign portfolio investment
- Growth Prospects: The growth potential in the economy of the country being considered for investing.
- Interest Rates: Investors prefer to invest in countries where the interest rates are high.
- Tax Rates: We have a capital gains tax that is levied on the returns of your investments. Higher the tax rate, lower your return from the investment. So investors lookout for countries where the tax rates are comparatively lower.
Indian markets and FPIs
Onto to the most important part — Why do Indian financial markets react to the buying/selling activities of FPIs?
The manner in which these investors enter the markets is worth noting. The FPIs invest by entering huge blocks of trades and the buying/selling of a massive number of assets in the markets can sharply impact the asset prices owing to the supply/demand being affected.
For example, when there are FPI inflows into the stock markets, there is a rise in demand for the assets due to which the stock prices rise.
Thus, having a lookout for FPI activities can be a way to understand what the foreign players are expecting from the Indian markets. The FPIs have a sound analytical and research team that backs their entries in the foreign markets based on valuations and expected returns. However, whether these decisions are absolutely right or not, is debatable as the market conditions can swiftly change.
Here is a chart that overlaps the Nifty data with the monthly FPI activity in India:
From the chart, we can observe that the FPI Monthly Investment is clearly correlated to Nifty’s performance.
Recently, FPIs were in the news as there was a net withdrawal of funds by the FPIs in India, so far, in the month of April 2021. The total withdrawal of funds approximates 929 crore rupees. This news arrived owing to the rising COVID-19 cases in India and the depreciating rupee.
What are your views about the FPIs withdrawing their investments? Do you think this will be a scenario for one or two months, or that we would be seeing more such withdrawals in the year to come?
