Mutual Funds Down as FIIs Dump Indian Equities. What Should Investors Do?

This significant offloading can be attributed to several factors. As valuations in various pockets in the Indian equity market turned expensive FIIs have been reallocating funds to other emerging markets like China, where valuations appear more attractive. US President Donald Trump's trade policy and its impact on emerging markets is another reason for this exodus. US bond yields and Dollar have gained significantly in the last few months, becoming a safe haven for FIIs. Additionally, a weaker-than-expected Q2FY25 and Q3FY25 earnings season in India and a slump in the manufacturing segment have fuelled concerns.

Equity mutual funds across categories are now down sharply amid the broad-based decline in the Indian equity market. Since late September 2024, the Large Cap Fund category has witnessed a decline of 14.8% on an average, Flexi Cap Funds have declined by 16.5%, Mid Cap Funds by 18.2%, and Small Cap Funds by 20.2%.

DIIs offer crucial support

It is worth noting that the impact of a record high selloff by FIIs on the equity market would have been harsher but for the resilience displayed by domestic investors. Domestic Institutional investors, led by mutual funds, have been persistently registering substantial inflows month after month offering crucial support against the market volatility in the face of intense selling by foreign investors. In the current financial year so far, they have net bought equities worth a staggering Rs 4,34,787 crore. Mutual funds are typically preferred by small retail investors and a sharp rise in folios and inflows in the industry over the last few years has worked as a catalyst for higher purchases by these schemes.

The Finance Minister too took note of the fact that the Indian market is no longer at the mercy of FIIs. According to Ms Nirmala Sitharaman, there has been a shift in trend from Bank Fixed Deposits, Post Office Savings, and other such traditional investments to equity market, either through mutual funds or direct equity investment via Demat account. According to her, this is a healthy trend as when FIIs flow out of India there is no huge shock as retail investors are there to absorb the shock.

Will DIIs continue to offer a cushion against FII selloffs?

As per a Business Standard report, redemption from India-dedicated funds continues to be a significant pressure point. Capital flows in India have remained negative for the fifth consecutive month, though the pace of outflows has slowed down. Such pace outflow underscores the broader trend of investor withdrawal from India-focused investment vehicles. The report further added that elsewhere, foreign fund flows are stabilizing across most emerging markets with the exception of India.

FII typically prefer strong and well-established companies and naturally, they have a higher presence in the large-cap segment. They generally avoid investing in overvalued stocks as well as stocks in the mid and small-cap segments which leaves domestic investors exposed to high risk assets. If global uncertainties continue to play spoilsport, investors in the mid-cap and small-cap segment may continue to be hit hard, though the large-cap segment may offer some comfort, mitigating the downside risk.

So, while domestic investors have offered a cushion against FII withdrawals, one should not be complacent, expecting the uptrend to continue without any blip. The recent months have proved that FIIs still continue to hold strong ground, impacting overall market sentiments.

What should investors in mutual funds do?

Despite intense withdrawals in recent months, FIIs continue to exude confidence regarding India's long-term prospects and may make a comeback when US Dollar stabilises. The impact of FII selloff on the market is often temporary and if you sell investments in such phases, you can accrue losses. If you have a long-term investment horizon, volatility in the short run may not significantly affect your ultimate returns significantly. Over the past decade, markets have witnessed multiple instances of heavy FII selloff, resulting in severe market declines, yet market ended positive in 9 out of the past 10 years.

If you have a significant portion in high-risk funds such as Mid Cap Funds and Small Cap Funds that have been the worst hit during the selloff, consider rebalancing or diversifying.

For investors looking for fresh investments or to top up their existing holdings now is an opportune time because a market correction allows fund managers to pick quality stocks at reasonable valuations which can benefit investors significantly when the market recovers.

So even though seeing your mutual funds down can be unsettling, investors should avoid knee-jerk reactions. Long-term investors should focus on their broader investment strategy, staying disciplined, and maintaining diversified portfolios. If in doubt, a discussion with a financial advisor can provide tailored insights based on personal investment goals.

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DIVYA GROVER is the co-editor for FundSelect, the flagship research service of PersonalFN. She is also the co-editor of DebtSelect. Divya is an avid reader which helps her in analysing industry trends and producing insightful articles for PersonalFN’s popular newsletter – Daily Wealth letter, read by over 1.5 lakh subscribers.
Divya joined PersonalFN in 2019 and has since then used stringent quantitative and qualitative parameters to analyse funds to provide honest and unbiased research to investors. She endeavours to enable investors to make an informed investment decision and thereby safeguard their wealth.

Disclaimer: Investment in securities market are subject to market risks, read all the related documents carefully before investing.
This article is for information purposes only and is not meant to influence your investment decisions. It should not be treated as a mutual fund recommendation or advice to make an investment decision in the above-mentioned schemes.