Emerging Markets: Increasing Domestic Retail Participation and Declining Role for Foreign Investors
Historically, Foreign Institutional Investors (FIIs) have been a major driving force in Emerging Markets (EMs). As soon as an Emerging Market opens up, the FIIs get interested because of scarcity premium and usually better economic growth potential. The size of these markets is usually small and daily trading volumes are on the lower side. Hence, the entry and exit of FIIs could make a big impact on the market direction and how the market indices and individual stocks perform.
FIIs may not always outperform but they have two significant advantages vs. domestic investors, a) they can look at other comparable markets and this is not just in EM space and other markets globally but they can also look at other asset classes and then decide how attractive equities in a particular EM look like, b) the FIIs track news flow carefully and diligently but they don’t get too exuberant or excessively pessimistic unnecessarily and they will approach an EM with more equanimity.
But, do FIIs remain equally important forever and what could change in this equation where an EM equity index for a country is dependent on investor sentiment among FIIs and domestic investors. As the local economy grows, the savings get accumulated faster and the pile gets bigger and bigger. In relative value terms, the amount of money that could flow in from FIIs vs. inflows from domestic investors may get smaller. In several markets, it is possible the FII vs. Domestic Investors mix will get more balanced as the time progresses.
There is another side of this and that depends on how retail domestic investors will look at equities as an investment option. The relative attractiveness of equities is dependent on three major factors, a) the rate of return from fixed income options such as Bank Deposits, b) the returns that can be made by investing in real estate, c) how the price increase potential of other choices like Gold look like. More than absolute levels of interest in equities, the outlook for other available choices will make a bigger difference when it comes to investor sentiment.
Several emerging market fund managers also talk about how media coverage on equities in local newspapers and online mediums also play a role. While the local news flow sentiment driven by media coverage on equities is certainly important for an EM, this is a double-edged sword. Mostly the coverage is like a pendulum, traversing from one extreme of positive to the other extreme of negative. So, this doesn’t always remain in favor or equity markets and bring in retail domestic investors.
Overall FIIs will remain important for market movement in the EMs but usually in a decade or two depending on growth rates in local economy and investor sentiment towards other investment choices, the level of importance could vary. The domestic investors may get more prominent and while that will be good for stability of the markets in some cases, it will also be possible that this could make the job of FIIs a bit more difficult on how many arbitrage opportunities they can find in EMs. Nevertheless, this will remain an important variable to track for judging investor sentiment in these markets.
EM Alpha LLC
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EMAlpha, a data analytics and investment management firm focused on making Emerging Markets (EMs) accessible to global investors and unlocking EM investing using machines. EMAlpha’s focus is on Unstructured Data as the EMs are particularly susceptible to swings in news flow driven investor sentiment. We use thoroughly researched machine learning tools to track evolving sentiment specifically towards EMs and EMAlpha pays special attention to the timely measurement of news sentiment for investors as these markets can be finicky and sentiment can be capricious.Our team members have deep expertise in research and trading in multiple Emerging Markets and EMAlpha’s collaborative approach to combining machine learning tools with a fundamental approach help us understand these markets better.
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