“IMPACT OF FOREIGN INSTITUTIONAL INVESTMENT

ON
INDIAN MUTUAL FUNDS”

Submitted under requirements of Semester II

SUBMITTED TO: - SUBMITTED BY:-

DR. SWATI UPVEJA DEVIKA (48)

AADIL KAKAR (42)
PRIYANKA GAUR (56)
GUNEET CHITKARA (49)

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 TABLE OF CONTENTS

SR. NO. NAME OF CHAPTER PAGE

NUMBER

1 EXECUTIVE SUMMARY 3

2 INTRODUCTION 4

3 OBJECTIVES OF STUDY 19

4 SCOPE OF STUDY 20

5 LIMITATIONS OF STUDY 21

6 LITERATURE REVIEW 22

7 METHEDOLOGY 29
ANALYTICAL TOOLS
DATA

9 RESEARCH FINDINGS AND ANALYSIS 30

10 CONCLUSIONS 37

11 SUGGESTIONS FOR FURTHER WORK 38

12 REFERENCES 39

13 APPENDICES 41

14 HYPOTHESIS TEST 44

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 EXECUTIVE SUMMARY

Foreign institutional investments (FIIs) have always been in news because

of their huge volumes and their skill to make the market take violent twist and
turns they are one of the hottest topics of conversation as well as study these
days.

Mutual funds have been around for a long time. Both FIIs and mutual funds
have a common linkage and that is the stock market It is common knowledge that
FIIs can drive the market index up and down and this in turn results in the Net
asset Value (NAV) of the mutual funds fluctuating FIIs have an immense
influence on the stock market since the bulk of their investment is in the stocks
that comprise the key indices and half of it is in the top five stocks that comprise
the key indices. However, what is also a very important aspect of study is the
probably impact of the FIIs on the mutual fund movements. Both the variables
under concern have a bright side as well as dark side Whether the b righter side of
the FIIs overshadows the darker side in terms of its impact on the mutual funds is
the subject of study the conceptual framework deals with this whole ideas.

Questions arise regarding the efficacy of mutual fund investments and their
correlation with FIIs. The investor needs to know this fine point and whether it
will affect his choice of investment. The entire data on mutual fund flows and FII
flows has been put to statistical tests. All this forms part of the findings and
analysis.

This research caters to an extent to the investing class and presents the
overall picture in the context of mutual funds. Whether the investors should
invest in mutual funds or not given the FII flows and their impact on mutual funds
in the subject matter of the recommendations and conclusions.

3
 INTRODUCTION

Background

Mutual funds can be referred to as financial intermediaries that allow group of

investors to pool in their resources and invest together with a predetermined
investment objective. The investments are taken care of by a fund manager who is
a part of an Asset Management company (AMC). The fund manager is a qualified
professional the puts this money into vehicles of investment such as stocks and
bonds. Various Schemes are in place in every AMC. An investor can choose any
number of schemes to invest his money Investors purchase the shares offered by
the mutual funds and in this manner the they create portfolios for themselves and
become shareholders of the mutual fund. They can sell their shares as per their
discretion However, the prices of the mutual fund shares fluctuate on a daily basis
since they are in turn dependent on the performance of the securities held by the
fund.

Mutual fund Operation Flow Chart

Figure 1

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History of the Indian Mutual Fund Industry

The mutual fun d industry in India started in 1963 with the formation of Unit
Trust of India, at the initiative of the Government of India and Reserve Bank the.
The history of mutual funds in India can be broadly divided into four distinct
phases.

First Phase – 1964-87

Unit Trust of India (UTI) was established on 1963 by an Act of Parliament. It was
set up by the Reserve Bank of India and functioned under the Regulatory and
administrative control of the Reserve Bank of India. In 1978 UTI was de-linked
from the RBI and the Industrial Development Bank of India (IDBI) took over the
regulatory and administrative control in place of RBI. The first scheme launched
by UTI was unit Scheme 1964. At the end of 1988 UTI had Rs. 6,700 crores of
assets under management.

Second Phase – 1987-93 (Entry of Public Sector Funds)

1987 marked the entry of non-UTI, public sector mutual funds set up by public
sector banks and Life Insurance Corporation of India (LIC) and General Insurance
Corporation of India (GIC). SBI Mutual Fund was the first non-UTI Mutual fund
established in June 1987 followed by Canbank Mutual Fund (Dec 87), Punjab
National Bank Mutual Fund (Aug 89), Indian Bank Mutual fund (Nov 89), bank of
India (June 90), Bank of Baroda Mutual fund (Oct 92). LIC established its mutual
fund in June 1989 while GIC had set up its mutual fund in December 1990. At the
end of 1993, the mutual fund industry had assets under management of Rs.47,004
crores.

Third Phase – 1993-2003 (Entry of Private Sector Funds)

5
With the entry of private sector funds in 1993, a new era started in the Indian
mutual fund industry, giving the Indian investors a wider choice of fund families
Also, 1993 was the year in which the first mutual Fund Regulations came into
being, under which all mutual funds, except UTI were to be registered and
governed. The erstwhile Kothari pioneer (now merged with Franklin Templeton)
was the first private sector mutual fund registered in July 1993.

Fourth Phase – since February 2003

In February 2003, following the repeal of the Unit Trust of India Act 1963 UTI
was bifurcated into two separate entities. One is the Specified Undertaking of the
Unit Trust of India with assets under management of Rs.29,835 crores as at the
end of January 2003, representing broadly, the assets of US 64 scheme assured
return and certain other schemes the Specified Undertaking of Unit Trust of India,
functioning under an administrator and under the rules framed by Government of
India and does not come under the purview of the Mutual Fund Regulations.

The second is the UTI Mutual fund Ltd, sponsored by SBI PNB, BOB and
LIC. It is registered with SEBI and functions under the Mutual Fund Regulations.
With the bifurcation of the erstwhile UTI which had in Marcy 2000 more than
Rs.76,000 crores of assets under management and with the setting up of a UTI
Mutual Fund, conforming to the SEBI Mutual Fund Regulations, and with recent
mergers taking place among different private sector funds, the mutual fund
industry has entered its current phase of consolidation and growth As at the end
of September, 2004, there were 9 funds which mange assets of Rs.153108 crores
under 421 schemes

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 Mutual Fund Structure

SEBI

TRUSTEE SPONSOR

OPERATIONS AMC
SEBI

FUND MANAGER
MKT./SALES MKT./SALES

MUTUAL FUND

DISTRIBUTOR
SCHEMES

INVESTOR

Figure -2

7
Advantage of Mutual Fund

√ Mutual funds have become very popular investment avenue since they
provide cost efficiency. They help invest even small amounts of money.
Trading costs are much lower than what the individual investors would have
to bear if investing on their own.

√ Another advantage is liquidity. Shareholders can buy or sell their mutual

fund shares any day, any time. This makes the money easily accessible for
them.

√ Convenience is another very important plus point of mutual funds. The fund
scan be bought and sold anytime through various means such as telephone,
mail or Internet. This helps the investors to move their money according to
the change in their financial requirements expenses can be met through
automatic transfers from the fund to the bank account of the investor. Most
of the AMCs offer an extensive array of services that include efficient
record keeping that allows the investors to keep track of the fund
performance, their transactions and also to complete their tax returns.

√ Yet another advantage that makes mutual funds popular is the existence of
professional management. Investors normally do not have the time to keep
track of their personal investments. The investment advisors thus step in
and act on behalf of the investors to manage their investments to reinvest
their income from dividends or interest and also to investigate the large
number of investment options (securities) that are present in the financial
markets.

√ However the biggest advantage with mutual fund investment is

diversification. This helps in lowering the risk since the money gets
invested in multiple stocks So, if one stock is down the other might be up
the potential losses can thus, be obviated.

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√ Transparency, income growth safety and a good post tax return are some of
the other advantages.

Banks, financial institutions, private companies or international firms usually

sponsor the asset management companies among the bank-sponsored mutual
funds, UTI Mutual Fund holds the bulk of assets and the SBI Mutual Fund follows
it In the Indian Mutual Fund category, Reliance Mutual Fund, Kotak Mutual Fund
and Tata Mutual Fund are the major players Among the India-dominated joint
ventures are big names like HDFC Mutual Fund, DSP Merill Lynch Mutual Fund
and Birla Sun Life Mutual Fund. The last category is that of foreign-dominated
funds like Franklin Templeton Mutual Fund, Prudential ICICI Mutual Fund,
standard Chartered Mutual Fund and HSBC Mutual Fund (the Economic Times
Report 31 January 2005).

Figure 3

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 Growth rate of Indian MF Industry

0.5
0.45
0.4
0.35
0.3
0.25
0.2
0.15
0.1
0.05
0
1999 2000 2003 2007 2011 2013

Figure 4

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Mutual Fund Companies in India

√ ABN AMRO Mutual Fund

√ Birla Sun Life Mutual Fund

√ Bank of Baroda Mutual Fund

√ HDFC Mutual Fund

√ HSBC Mutual Fund

√ ING Vysya Mutual Fund

√ Prudential ICICI Mutual Fund

√ Sahara Mutual Fund

√ State Bank of India Mutual Fund

√ Tata Mutual Fund (TMF)

√ Kotak Mahindra Asset Management Company

√ UTI Asset Management Company Private

√ Reliance Mutual Fund (RMF)

√ Standard Chartered Mutual Fund

√ Franklin Templeton Mutual Fund

√ Morgan Stanley Mutual Fund

√ Escorts Mutual fund

√ Alliance Capital Mutual fund

√ Benchmark Mutual Fund

√ Canbank Mutual Fund

√ Chola Mutual Fund

√ LIC Mutual Fund

√ GIC Mutual Fund

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 Foreign Institutional Investments (FIIs) are a form of Portfolio inflows
Portfolio inflows have come to play a very significant role in the economies of
developing nations, India being one of them Before 1991, the Indian financial
sector was marked by a closed capital account and strict administrative controls
on the capital mobility. India opened up its stock market to portfolio inflows in
September 1992 in response to the need for international capital and since 1993 it
has received considerable inflow in the form of FIIs inviting in equities. Another
reason for easing the entry of FIIs was the need to avoid the piling up of
unsustainable burden with debt of the classical type FIIs presented themselves as
non-debt crating instruments and thus, appeared superior The FII route has
become a main channel for the foreigners to invest in India. These foreign
investments have shown a tremendous presence in the Indian market, notable
especially in the last two years – 2003 and 2004. Both demand side as well as
supply side factors motivate these international investments. Those institutional
investors, who cannot directly enter the capital market, take the path of mutual
funds. Hence, their buying and selling activities, apart from having an impact on
the financial markets, also leads to mutual fund fluctuations.

The quantity, quality and nature of these FII flows need to be regulated and
monitored very carefully since they can unintentionally hamper the local
investors by their unbalanced diversification and hidden risks. Notoriously
referred to as “hot money” these flows are marked with high volatility as
compared to other form of capital flows.

FIIs are an important component of capital flows. They normally invest in

mutual funds, pension funds or insurance companies Thus, such flows are
determined in a big way by the performance of the host country’s stock market
vis-à-vis the world markets In India, they are required to get themselves
registered with the Securities and Exchange Board of India (SEBI) so as to be
allowed to invest directly in the equity shares of the companies on the stock
exchanges. The FIIs registered with SEBI come from as many as 28 countries and
this includes the AMCs operating in India on behalf of foreign investors.
Regulations, thus, need to be synchronized; inflows from the foreign institutional
12
investors (FIIs) must be regulated in the equity market, as the domestic funds
should have a level playing field with them.

The parameters on which SEBI decides FII applicants’ eligibility

(a) Applicant’s track record, professional competence, financial soundness,

experience general reputation of fairness and integrity. (The applicant
should have been in existence for at least one year).

(b) Whether the applicant is registered with and regulated by an appropriate

foreign Regulatory Authority in the same capacity in which the application
is filed with SEBI

(c) Whether the applicant is a fit & proper person.

The Indian Scenario

India is one of the most attractive emerging markets today for foreign investment.
The market of a country that presents a high-risk situation but also holds the
potential for high returns characterizes and merging market. These markets are
also marked by a high degree of volatility.

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 Figure – 5

The above chart shows the rise that has been witnessed in the number of FIIs
registered with the stock market regulator in India-Securities Exchange Board of
India (SEBI) was formed in 1988 and was given the responsibility of preparing a
comprehensive set of guidelines for the regulation of the mutual funds.

These guidelines lay down the rules for the formation, administration and
management of the mutual funds disclosure requirements are also mentioned. In
November 1995, SEBI issued guidelines that ere largely based on the ones issued
earlier in 1992. These guidelines required the FIIs to obtain approval from the
Reserve bank of India (RBI) under the Foreign Exchange Regulation Act, 1973.
Once they received the approval, they could buy and sell securities, open banks
accounts both rupee and foreign currency, and also were enabled to remit and
repatriate funds. Full convertibility of Rupee was applicable for the FIIs. Over
time, the scope for the FIIs has expanded by permission to additional categories
of investors and by identification and recognition of other instruments where they
can invest.

The flow has also been aided by the falling dollar. These flows have been
cited as the prime reason for the Bull Run being witnessed in the Indian stock

14
market. However, the appreciation of rupee in turn has the ability to hurt the
exports. Thus there exists a paradoxical situation whereby a free market
philosophy is professed on the one hand, while on the other hand a controlled
regime is required. It has often been argued that the FIIs have brought with them
“good” things such as transparency, liquidity and volumes.

Foreign Direct Investment (FDI) is any day better than investment by

foreign investment (FII) the difference between FDI and FII is that FDI creates
assets and generates jobs while FII is an investment in the existing stocks and
shares where the Foreign Institutional Investors (FIIs) buy and sell shares of
Indian companies to make profits; FII does not generate assets and does not create
jobs.

In India the FII money is coming in a big way than FDI, while it is the
other say round in china, which is our competitor in the international market for
number of goods and services. Foreign Investment refers to investments made by
residents of a country in financial assets and production process of another
country.

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Relevance of the study for the investors

The issue is contentious since a huge proportion of the population is still devoid
of easy access to capital markets for fruitful investments. Often, FIIs do not act
rationally and excessive dependence on them can have disastrous consequences
for the economy. FIIs are the first to-flee in case of any undesirable
circumstances and this necessitates the need for having a strong domestic support.
The FII flows also have another dark side. They normally invest in the top-rung
companies and this crates a buying pressure, which forced the indices upward,
quite analogous to the rise in the price of a commodity due to a heightened
demand This leads to a cascading effect on even the undeserving stocks among
others and because of the heavy manipulation that follows, the promoters and
operators manage to escape the scrutiny. As a result, the small investors who are
looking for cheap bargains get maneuvered into such stocks.

The mutual funds pose a challenge to the banks of large and small cities
because of their simplicity and convenience and thus have com to preponderate
the Indian financial services scenario.

Investor education holds tremendous importance they need to be

enlightened about the various schemes being offered by the different Mutual
funds. All investors today can access all information about them. Differ ent
categories of mutual funds have varied investment objectives. Similarly, different
investors have different objectives of investing in thee widely diverse mutual
funds. These objectives could be as varied as earning capital gains, or regular
dividend stream, or tax-saving purposes and so on. However, emphasis is to be
laid on the need to realize that the market can prove to be highly erratic and
volatile in the short run and significant amounts of money may be lost. Thus, the
investors need to be aware of the benefits of long-term investments and that is
when they should turn to mutual funds.

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 The investors have to undertake certain important considerations before
putting their hard-earned money into mutual funds. These can be listed as
follows:

√ Mutual funds are not simply short-term tools to speculate in the market.
They fluctuate according to the changing market conditions but they cannot
be used to enter and exit the market. Mutual funds are actually long term
investment avenues for the investors. Also the investors need to ensure that
a Systematic Investment Plan (SIP) is followed while placing their money
in the mutual funds. This implies that a specified sum of money is invested
on a regular basis each month for an extended period of time.

√ The next most important factor to track a mutual fund is the Net Asset
Value (NAV). Analogous to share prices, the mutual funds have an NAV,
which is the value of the assets of the scheme after considering the
liabilities; it is calculated per unit so that the investor knows how much
each unit of the scheme is actually worth the NAV thus needs to be kept
track of. It is declared by the mutual funds in the newspapers on a daily
basis.

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Among the other factors the investor must consider

√ Portfolio of the scheme is crucial. This is because the performance of the

scheme ultimately depends on its portfolio, its composition and how the
fund manager manages and changes it. This is a very important indicator of
the risk associated with the portfolio. The extent of diversification in the
portfolio is also an indicator of the riskiness of investment.

√ Finally, the cost aspect of the fund also requires consideration. Managing
and administration of a fund requires a lot of costs and these are usually
covered up from the investors through the NAV. The investors thus need to
ascertain the costs involved in various schemes and a comparison with the
other schemes can play a vital role in the final analysis of the expected
return.

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 OBJECTIVES OF THE RESEARCH

The objectives of this research are:

√ To determine the correlation between the two variables- FIIs and the mutual
funds,

√ To establish the cause and effect relationship between the stock market
index on the one hand and the mutual fund flows and FIIs on the other,

√ To understand the impact of the foreign institutional investments on the

movements of the Indian mutual funds,

√ To analyze and evaluate the effectiveness of investing in the mutual funds.

Mutual fund flows and FIIs can be regarded as independent variables whereas the
Index can be taken as the dependent variable with the help of correlation and
regression analysis, the causality between the index movements and the FII flows
and Mutual fund flows can be established Also the two independent variables are
interrelated, this will be proved with the help of this research.

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 SCOPE OF THE STUDY

This report basically aims at studying the growth of Mutual Fund industry and the
growth of Foreign Institutional Investments in India.

The impact of FII’s investments on Mutual fund flows has been also an
integral part of the study. The statistical models of correlation and regression
have been sued to bring out the dependency relation between the variables under
study viz. the Index S & P CNX Nifty, FII inflows and the Mutual fund flows.

Historical month wise data for past years have been taken for the purpose
of the study.

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 LIMITATIONS OF THE STUDY

The limitations of the study are as follows:

√ Historical month wise data for past years has only be taken for the study.

√ Others factors apart from FII’s flows affecting he Mutual Fund flows have
not been researched and are out of scope of this study.

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 LITERATURE REVIEW

Since liberalization in 1991 when India opened its doors to the rest of the world,
foreign portfolio inflows have been witnessed as a major occurrence. These flows
of which foreign institutional investments (FIIs) are a part have come to occupy a
very important place in the Indian economic system. They have had a profound
impact on the economy.

What follows is a critical review of some of the articles written in the

context of FIIs and mutual funds.

Hess, in his article aims to throw light on the major factors that are
responsible for building the confidence of the investors so that they are driven to
invest in the equity markets of developing countries and ultimately aid in their
economic development. India has been taken as a case in pint to define “emerging
equity markets” with the help of the characteristics it exhibits such as below a
rage per capita gross domestic product, government regulations regarding foreign
ownership in domestic companies, greater perceived investment risk than in
developed markets etc. Once the confidence is generated among the investors
through factors such as the government commitment towards efficient
development of not only the banking system but also the securities markets, well
ensconced contract and securities law and well qualified and deft market
participants and fund managers, the foreign direct investment and foreign
institutional investment is given a fillip and this reflects itself in greater
economic development for the country. In India, the commitment process begin
the early 1990s also the securities Exchange Board of India (SEBI) was
established in 1988 to enact and put into force the securities law plus, the
Bombay Stock exchange carries out training programmes to equip the market
participants with the necessary skills and knowledge.

The international trend has shown a move away from the floor-based system
towards a screen based trading system. With such as system, the participants are
able to see the entire market along with maintaining control and preventing fraud
22
by establishing transparent audit trails. India has also shown signs of movement
towards such a system The National Stock Exchange is a very good example of
state of the art automated trading system.

Investor confidence can dwindle if the information disclosure is not full

and fair Full disclosure requires that all information relevant to business
operations in made available to the investors so tat they can make an informed
decision regarding their investments. Fair disclosure requires that the
information must be made available to the entire market and not just to a few
insiders. Disclosure rules and regulations are clearly mentioned in the guidelines
issued by the Securities and Exchange Board of India (SEBI), with which all the
FIIs are required to register.

The worldwide trend towards privatization has also had its impact on the
merging equity markets. It has resulted in a stimulation of private businesses to
offer their own shares to the public and this has been instrumental in opening up
of financial services such as mutual funds and pension funds to the private sector.

Countries that wish to see a growing equity market need to change their
attitude towards foreign investment Barriers need to be removed and foreign
exchange agreements need greater flexibility India has taken steps in this
direction Post liberalization India has also eliminated most forms of import
licensing thereby creating an environment that is less distortionary towards the
local newcomers and foreigner investors. Capital gains tax also discriminates
against foreign investors since they cannot provide evidence of capital losses as
easily as the domestic investors and this reduces their confidence. In India, long
term capital gains tax has been done away with while the sort term capital gains
tax stands at 10%.

The need to create efficient equity markets has been very rightly
emphasized. To be recognized as “emerging” a country needs to show signs of
progress in the positive direction since this is a very critical ingredient for
generating confidence in the international investing community. India is one of

23
the fastest growing emerging markets today. And since the foreign institutional
investors (FIIs) are increasingly getting attracted towards the emerging markets it
is very important to investigate the relationship between theses FII inflows and
the equity returns. This article attempts to identify the factors that are crucial for
drawing FIIs to India. Once the FII come in only then can the resulting
fluctuations in the stock markets and the mutual funds be studied.

Tripathy’s article attempts to analyze the importance and growth of mutual

funds and to evaluate their operations. The article also suggests some measures
that could be undertaken to make the mutual funds a successful scheme in India.
With progressive liberalization of economic policies, the capital market and the
money market have been growing very rapidly Alongside, the financial services
industry that includes merchant banking, leasing and venture capital has also seen
a very rapid growth In such a scenario the mutual fund industry has also come to
occupy an important place.

Mutual funds hold immense importance since they provide the much-needed
help to the small investors These investors have very limited access the much-
needed help to the small investors. These investors have very limited access to
resources and information and are not able to gain adequate professional advice
on where to invest their savings. Through mutual funds, these investors can pool
their savings and under the auspices of a tam of experts, their saving are invested
in a wide variety of portfolios of corporate securities. This is done so as to
minimize the risk and at the same time ensure a safe and steady return on
investments.

Another important point is that the dividends and capital gains are
reinvested automatically in mutual funds and hence are not fritted away. This thus
takes the form of forced savings that can go on to make a very big difference in
the long run. A very notable point is that mutual funds attract foreign capital flow
to the country and also secure lucrative investment avenues abroad for domestic
savings. This is done through off-shore mutual funds that have been launched by
foreign banks, some Indian banks like State Bank of India (SBI), Canara bank etc

24
and the UTI the main aim of this scheme is to facilitate the movement of capital
from the cash-rich countries to those economies that hold potential for high
growth.

Certain shortcomings in the operations of mutual funds such as the fact that
mutual funds are externally managed and that they do not have employees of their
own, have been taken care of. Also uniform coordinated regulations are now in
place to provide a safe haven to the investors.

Mutual funds in India were formed as trusts and the trustees themselves
play the role of fund managers. A distinction in the roles of trustees, sponsors and
fund managers in now in place their activities have been clearly demarcated since
this will ultimately protect the interest of the small investors.

Finally, transparency in mutual funds had not been adequately attended to

this needed to be taken care of as the investors have the right to know how their
money has been deployed Fair and truthful disclosures are ne3eded, which is a
very important thing to be looked at so that the inventors are aware of the risk
levels involved. This to an extent has been take care of by SEBI.

To sum up, the article deals with the entire framework within which the
mutual funds operate. Without a well-etched and technologically advanced
mechanism, the Indian mutual fund industry will not be able to match the world
standards.

A weak and inefficient infrastructure has been pointed out as a deterrent to

attraction of foreign investments. Even though projects for the betterment of rural
areas in terms of roads, sanitation etc have been taken up, the efforts still need to
be in place with full swing the problem of electricity has caught India in its grip
since ages and due to this very limited power supply; many businesses have had
to set up their own power generators.

25
 The labor laws in India are also of a highly inflexible nature. India holds a
good position in terms of skilled labor, which is available in abundance. However
the required flexibility is lacking as a result of the many different laws and
regulations regarding the disputes in the change in service conditions.

Corruption has spread like an epidemic in the Indian economic and political
system. Sometimes even the politicians, in candid speeches have admitted that the
entire system is marked totally by corruption. Bribery is a common phenomenon.
From the distribution of subsidized food to the poor, to the transmission of
electric power, corruption shows its presence everywhere The bureaucratic
structure is such that a lot of paper work has been made mandatory because of
which even a simple matter needs a long time to get finished This is a major
deterrent for the foreign investors.

To conclude, it is rather irrelevant to the foreign investors whether the

country is democratic or communist. What they seek is access to the emerging
markets of developing countries, a safe and secure return on their investments and
a stable political environment of the host country.

Priju et.al (2004) have analyzed the impact of the foreign institutional
investors (FIIs) on the volatility of the Indian Stock market. This has been done
as a prerequisite to test the case of having a hedge fund industry in India
Alongside the impact of the index has been studied with regard to FIIs and Mutual
fund flows Nifty has been chosen for the study since the bulk of FII activity takes
place on this index and because it is the dominant exchange in India Monthly data
has been used for the period of January 2000 to December 2005 since this period
captures the conspicuous peaks and dips in the Indian market Quantitative
techniques of correlation and regression have been made use of to test the
hypothesis that there is a significant impact of the FII flows on the Nifty
volatility.

26
 This report can prove to be very helpful since one of the objectives of this
research is to establish the correlation between the mutual funds and FIIs this will
be attempted with the help of past data it also makes use of regression analysis,
which is also the framework for this study With the help of regression, the
variation in the stock market index due to mutual fund flows and FIIs will be
brought out and in the process correlation between the latter two variables will be
shown.

This importance of FIIs is in reality not applicable to emerging markets

because these markets lack transparency in information. They enter the markets of
these economies on the grounds of a much lower quality of information Emerging
markets like India show a huge future potential, which attracts the FIIs. However,
the market regulations are not well synchronized, which results in mayhem. This
deters the FIIs the FIIs increase the capital supply in the economy and result in
an investment boom’, but the need for a meticulous selection of the investment
project also goes hand in hand this is what is lacking in the emerging markets.

To sum up the findings from the review of literature, it can be said that
globalization has brought about widespread reforms in the economies of the
world, with a large number of them opening up to the foreign environment. An
amalgam of domestic and foreign investments in any economy proves to be
beneficial for the economy eventually. The policies of the nations such as China,
Singapore and other Far East countries were restructured timely and this helped
them get on the path of liberalization much earlier than a country like India.

The Indian economy has also undertaken a wide range of reforms that
includes reduction in quantitative restrictions on imports, reducing the taxes
imposed on foreign investors, doing away with the foreign exchange controls etc.
Recently, the finance minister Dr. P. Chidambaram announced an FDI limit of up
to 74% in sectors such as telecom, civil aviation and insurance. Also, 100% FDI
has been approved in the construction sector. All these measures as indicative of
a progressive economy.

27
 The mutual fund industry in India exhibits the fact that many of the
proposed suggestions have been implemented. Private sector mutual funds have
forayed in the market, there are professional fund managers to take care of the
needs of the investors, and all the dealings have been computerized. In fact,
dealings can also be done online through websites. Technological advancements
have been integrated with the mutual fund transactions so as to take the industry
to higher levels marked with speed and efficiency so as to match up to the global
standards.

The current FII status strongly suggests that the number of registered
foreign investors with the SEBI has been growing over the years and will
continue to show an upward trend in future. They have come to occupy a
dominant position in the India economy and hence, cannot be ignored. Also, since
these inflows are under constant supervision of SEBI their volatility is kept under
check there have been arguments against the need for FIIs into the country on the
pretext that dependence on financial capital drives the obsession to curtail the
fiscal deficits and proves to be a barrier to the creation of seal wealth. However,
what is true and what is not calls for investigation. There is enough evidence to
corroborate the fact that foreign investments are good for and merging market
like India.

Through this research project a correlation between the FIIs and Mutual
Funds in India will be worked out and the mutual fund fluctuations in the light of
these foreign inflows will be analyzed so as to evaluate the investments in the
Indian mutual fund industry.

28
 METHODOLOGY

India has seen a steady growth in FII inflows since the opening up of its markets
as a part to liberalization and since then there has been no looking back. The
market environment has undergone a drastic change and has become much more
creative and competitive thereby resulting in the growth of the issuers of
securities and intermediaries these FII inflows have come to become the
preponderant owners of the free float of most blue chip Indian stocks As a result
of which, they have a major impact on the market volatility. It is this volatility
that will be understood hereon.

Analytical tools

The statistical models of correlation and regression have been sued to bring out
the dependency relation between the variables under study viz. The Index S&P
CNX Nifty, FII inflows and the Mutual fund flows. With the help of the
correlation statistic, the degree of correlation between the proposed variables can
be understood and this further corroborates the results obtained from regression
analysis.

Data

For the proposed study the index considered is S&P CNX Nifty i.e. the National
Stock Exchange (NSE) benchmark index. This is because NSE is the dominant
stock exchange of India and the major chunk of FII activity takes place on this
exchange. The data considered is monthly data of Nifty, FII flows and the mutual
fund flows from January 2013 to December 2018. the period from 2013 to 2018
has been selected since this period captures some of the great peaks and dips in
the Indian market. Also, this period marks some significant developments in the
financial markets such as rolling settlements, derivatives etc.

The Data has been taken from Internet sites: www.moneycontrol.com,

www.nse.com, www.matualfundsindia. com journals, books and internet.

29
 RESEARCH FINDINGS AND ANALYSIS

Regression analysis

Regression analysis is used primarily for the purpose of prediction. The main aim
of this statistical tool is to predict the values of a dependent variable (response
variable) based on the values of one of more independent variables (explanatory
variables).

Using the Index – S & P CNX Nifty as the dependent variable (Y) and the
FII inflows and Mutual Fund flows as the independent variables (X1 and X2
respectively), a regression analysis was carried out to determine the extent to
which the index is dependent on the FII inflows and mutual fund flows.

The entire analysis was looked at tin two parts.

Case I

In this case, the lag variables were not been taken. The variables were defined as
follows:

Dependent variable: Nifty

Independent variables: FII inflows and Mutual fund flows

The hypothesis was framed as follows:

H 0 : FII inflows and Mutual Fund flows have a significant impact on the nifty
variations.

H 1 : FII inflows and Mutual Fund flows do not have a significant impact on
the nifty variations.

30
Firstly, a simple regression was carried out so as to evaluate the effect of FII
flows on the nifty volatility. This yielded the Adjusted R square value of: 0.224

This meant that 22.4% of the variation in the nifty could be explained by the FII
inflows.

Next mutual fund flows were introduced as an additional independent variable.

Regression analysis with these two independent variables yielded the value of
Adjusted R Square to be: 0.8413

This implied that 84.13% of the variation in nifty could be explained by FII
inflows and mutual fund flows taken together.

This marked an increase over the previous value and was indicative of the fact
that mutual fund flows did have much affect on the nifty movements

The regression equation thus obtained can be written as:

Y i = -119.83 + 0.0273 X 1 + 0.0123 X 2

Here,

ß 0 is 119.83, which implied that even if the FII inflows and mutual fund flows
were not taken into account, the nifty moved to the tune of -119.83 units.

ß 1 is 0.0273, which implied that if mutual fund flows were kept constant, for a 1-
unit change in the mutual fund flows, the nifty changed by 0.0273 units.

ß 2 is 0.0123, which implied that if FII inflows are kept constant, for a 1-unit
change in the mutual fund flows, the nifty changed by 0.0123 units

F-Value is close to zero which confirms that the regression equation is linear and
Impact is significant.

31
Moreover p values of both the independent variables are less than 0.05 which
clearly shows that both FII and Mutual Funds Flows have impact on dependent
variables.

Together, FII inflows and Mutual fund flows explained a significant

percentage of the variation in the index (84.13%).

Therefore the null hypothesis was accepted. FII inflows and Mutual Fund flows
have a significant impact on the nifty variations.

This was also corroborated by the correlation coefficient ‘r’, which calculated the
degree of correlation between the nifty values and FII inflows.

Using the correlation function, r = 0.4846. This was a small value indicating a
low degree of correlation between the two variables this could also be seen from
the scatter diagram.

32
 Figure 7

Figure 7.1

Case II:

In this case analysis is done to establish any causal relation between FII flows
and Mutual Fund Flows.

Dependent variable: Mutual Fund Flows

Independent variables: Mutual Fund Lag Variables and FII flows

The hypothesis could be framed as follows:

H 0 : FII flows have a significant impact on Mutual Fund Flow.

33
H 1 : FII Flows does not have a significant impact on Mutual Fund Flows

Firstly, the Mutual fund flows were regressed with there first period lag variable.

This yielded the value of adjusted R Square as: 0.95165

This meant that 95.2% of the variation in the Mutual fund could be explained by
the first period lag variable.

Next, the second period lag variable was introduced and the regression analysis
was carried out.

The value of Adjusted R square was: 0.95288

This indicated that 95.3% of the variation in the mutual fund flows could be
explained by the two lag variables taken together.

Now, third Pd Lag variable was introduced and the regression analysis was
carried out.

The value of Adjusted R square was: 0.95266

This value was the less than the preceding value and therefore indicated that the
value of Adjusted R square had stopped increasing.

It was at this point that the new independent variable – the FII flows was
introduced to see Whether FII flows had any causal effect on Mutual Fund flows.

The regression analysis that followed yielded the value of adjusted R Square to
be: 0.953053

This implied that 95.3% of the variation in the Mutual Fund could be
explained by the two lag variables and the FII flows taken together. The third lag
variable was not included in the analysis since that was the point where the

34
Adjusted R square stopped increasing. This value marked an increase over the
previous value thereby implying that the FII did have a causal relationship with
the mutual fund flows.

The regression equation obtained can be written as:

Y i = 1978.67 + 1.2052X1 -0.2183X2 + 0.3502X3

Here,

ß 0 is 1978.67, which implied that even in the absence of the independent

variables, the Mutual Fund flows did change by 1978.67 units.

ß 1 is 1.2552, which implied that keeping all the other lag variables and FII
constant, with a 1-unit change in lag variable, there was a change in the Mutual
Fund by–1.2052 units.

ß 2 is (-)0.2183, which implied that keeping all the other lag variables and FII
constant, for a 1-unit change in the lag variable, there was a change in the mutual
fund by (-)0.2183 units.

ß 3 is 0.3502, which implied that keeping all the other lag variables with a 1`-unit
change in FII flows, there was a change in the Mutual fund by 0.3502 units.

F-Value is close to zero which confirms that the regression equation is linear and
impact is significant.

Moreover p values of first and third the independent variable (Mutual Fund first
Pd. Lag and FII Flows) is less that 0.05 which clearly sows that both FII and First
Pd.

Lag have impact on dependent variable (Mutual Funds)

35
As the p value of second variable is more than .05, it shows that it dos not have a
significant impact on the dependent variable and it can be dropped.

Thus, it could be said that the FII flows have significant impact on Mutual
fund flows.

Therefore, the null hypothesis was accepted.

This was also corroborated by the calculation of the correlation coefficient ‘r’.
r=0.3767.this was indicative of the fact that correlation did exist between the two
variables.

Correlation analysis produced a correlation coefficient of 0.485, which implies

that there is a relationship between the FIIs (independent variable) and the Nifty
(dependent variable). Simple regression analysis between FIIs and Nifty index
produced the result that 22.4% of the variations in the Nifty can be explained by
the FIIs. This is not a very significant figure. Multiple regression analysis taking
FIIs and mutual funds as the independent variables and Nifty as the dependent
variable came out with the finding that coefficient of determination is 0.841. This
implied that only 84.1% of the variation in the volatility in Nifty could be
explained by the two independent variables. Also, it was found out that
correlation analysis between FIIs and Mutual Funds produced the result that
0.3767 of correlation exist between the two and high correlation exists between
Nifty and Mutual Fund Flows (0.9066).

More over FII along with Mutual fund Lag variable as Independent
variables did have a significant impact of around 95.31% on the Mutual Fund
Flows.

36
 CONCLUSION

To conclude, it can be said that mutual funds still remain the safest investment
option, FIIs or no FIIs. This holds true especially for small investors who have
little knowledge about the market. As established by the analysis FIIs do have a
affect on the mutual funds flows, but investors need not worry about losing there
money due to FII flows volatility. The advantages associated with mutual fund
investments more than offset the negative effects that can be witnessed in the face
of FIIs. It should not be forgotten the mutual funds are not only of equity type
there are bond mutual funds as well as money market mutual funds Investments in
such funds provide the investors with the safety they need to be assured of along
with a decent level of returns /thus mutual funds cannot be written off. They are
very much on the scene and that too in a big way.

FII’s have both positive and negative aspect associated to it but after the
evaluation it is seen that FII volatility do not negatively impact the mutual fund
flows to a great extent and there is no need for the investor to panic

Efforts should be made in order to enhance investors confidence in Mutual

funds and steps should be taken in order to increase the domestic funds in the
stock market so that these large domestic funds provide a counter-balance to FIIs.
Even FIIs are major sellers during a particular month, Mutual funds can be the
major buyers and this would avoid too much volatility of stock markets and thus
safeguarding the interest of the retail investors.

37
 SUGGESTIONS FOR FURTHER WORK

This project report only covers the impact of FII’s flows on Mutual Fund flows
using statistical tools.

Further research could be done on the various other factors that affect the
Mutual fund flows and ultimately affect the investors Apart from FII, other micro
and macro economic variable factors could be taken into consideration and what
is there impact on the Stock market and Mutual fund flows.

38
 REFERENCES

Journal articles

√ Batra, Amita (2003) ‘The Dynamics of Foreign Portfolio inflows and Equity
returns in India’,

√ Frenkel, Michael, Menkhoff, Lucas (2003) ‘Are Foreign Institutional

Investors good for emerging markets?’, Discussion Paper No. 283

√ Hess, Dan W ‘Emerging equity markets in India: A case study’, Managerial

Finance

√ Priju, Thomas Joseph., ‘Building a case for Hedge funds in India on the
Basis of An Empirical Study of the Daily Impact of foreign Institutional
Investors Ash Inflows on the Nifty Volatility’.

√ Tripathy, (1996) ‘Mutual fund in India: a financial service in capital

market’.

Books

√ Statistical methods By S.P. Gupta

√ AMFI workbook

39
Internet Sites

• http://finance.yahoo.com/q/hp?s=%5ENSEI&a=01&b=4&c=
2000&d=11&e=31&f=2004&g=d

• http://www.crisil.com/indiabudget2004/markets/Post-MF report
210704.html

• http://www.moneycontrol.com/news/fiimf_activity/activity.php?flag-
=FII&month=200503.

• http://www.blonnet.com/iw/2004/05/02/stories/2004050200230600.htm

• www.SEBI.gov.in

• www.nseindia.com

• www.etintelligence.com

Other resources

The economic times

40
 APPENDICES

Months wise data for the past years (Jan’13 to Dec’18)

Mutual Funds FII (Rs. In Nifty

(Rs. in crore) crore)
Jan’13 1015.65 196.6 1607.8
Feb’13 1070.43 3084.1 1686.58
March’13 1130.05 1198.8 1605.66
April’13 1052.33 2586.7 1469.03
May’13 1040.32 252.7 1312.65
June’13 1077.28 934.8 1451.74
July’13 1030.89 1404.8 1545.62
August,13 1028.49 1217.4 1350.94
Sept’13 974.62 218.3 1371.27
Oct.’13 968.37 64.4 1201.27
Nov’13 995.20 905.4 1240.59
Dec’13 993.26 635.1 1291.43
Jan’14 1045.35 4273.3 1316.96
Feb’14 1024.35 1863.8 1371.91
March’14 905.87 1765.6 1214.47
April’14 931.01 1978.8 1116.41
May’14 967.95 676.1 1159.44
June’14 979.53 1179.7 1107.56
July’14 989.69 477.7 1077.98
August’14 993.36 504.7 1069.01
Sept’14 918.11 -1410.5 949.43
Oct.’14 945.71 884.4 953.92
Nov’14 9984.41 3.8 1031.62
Dec’14 1018.22 227.9 1075.87

41
Jan’15 1041.15 699.3 1087.2
Feb’15 1068.14 2336.8 1038.17
March’15 1005.94 329 1159.33
April’15 1028.31 -122.9 1120.74
May’15 1022.31 46.2 1079.8
June’15 1007.03 866 1065.9
July’15 1023.93 238.3 1034.7
August’15 1076.21 174.1 977.6
Sept’15 1069.29 332.4 987.12
Oct.’15 1131.53 -875.1 955.12
Nov’15 1213.93 737.7 992.26
Dec’15 1226.00 647.9 1074.04
Jan’16 1218.05 977.3 1073.48
Feb’16 871.90 428.2 1055.84
March’16 794.64 962.8 1016.38
April’16 892.38 992.5 965.08
May’16 981.24 3060.5 963.2
June’16 1047.62 3461.8 1068.59
July’16 1128.41 2160.9 1050.01
August’16 1210.40 2227.5 1261.13
Sept’16 1217.78 4175.5 1369.03
Oct.’16 1267.26 6722.8 1502.4
Nov’16 1323.66 3594.1 1580.02
Dec’16 1400.93 6381.9 1740.06
Jan’17 1453.72 3869.4 1906
Feb’17 1456.57 2673.5 1848.67
March’17 1396.16 6444.3 1779.63
April’17 1540.24 6719.5 1848.45
May’17 1540.18 -3546.4 1640.2

42
June’17 1558.45 -273.6 1906.1
July’17 1577.47 713.2 1568.08
August’17 1556.86 2609.7 1615.3
Sept’17 1531.08 2575.3 1691.56
Oct.’17 1479.95 2028 1794.98
Nov’17 1495.21 8185.3 1873.94
Dec’17 1505.37 10139.7 2024.67
Jan’18 1522.80 -316.6 1977.83
Feb’18 1532.53 9209.4 2067.39
March’18 1496.00 7926.6 2069.23
April’18 1584.22 -1475.5 1987.1
May’18 1679.78 -1385.8 2002.28
June’18 1645.46 5258.2 2134.29
July’18 1759.18 7760.2 2236.7
August’18 1957.84 4631.8 2357.56
Sept’18 2016.69 4458.4 2511.71
Oct.’18 2002.09 -2760.4 2486.79
Nov’18 2045.19 1874.2 2574.67
Dec’18 1992.48 8360.6 2772.61

43
HYPOTHESIS
TEST

44
Case – 1

Nifty Regressed with FII Flows

Regression Statistic
Multiple R 0.484624305
R square 0.234860717
Adjusted R Square 0.223930155
Standard Error 408.7253.55
Observations 72

ANOVA

df SS MS F Significance F
Regression 1 3589476.226 3589476 21.48661 1.6051E-05
Residual 70 11693949.11 167056.4
Total 71 15283425.33

Coeffic Standar t Stat P-value Lower Upper Lower Upper

ients d Error 95% 95% 95.0% 95.0%
Intercept 1304.9 60.1370 21.699 8.46E- 1185.0 1424.8 1185.0 1424.8
51064 4836 62 33 116 91 12 91
X Variable 1 0.0793 0.01712 4.6353 1.61E- 0.0452 0.1135 0.0452 0.1135
87227 6423 65 05 2968 45 3 45

Nifty Regressed with FII Flows and Mutual Fund Flows

Regression Statistic
Multiple R 0.919655155
R Square 0.845765603
Adjusted R Square 0.841295041
Standard Error 184.8316854
Observations 72

45
ANOVA

df SS MS F Significance F
Regression 2 12926195.45 6463098 189.1855 9.8232E-29
Residual 69 2357229.883 34162.75
Total 71 15283425.33

Coeffic Standa t Stat P-value Lower Upper Lower Upper

ients rd 95% 95% 95.0% 95.0%
Error
Intercept -119.8 90.373 -1.32 0.7892 -300.1 60.457 -300.1 60.457
39097 05279 597 23 21161 34 21 34
X Variable 1 0.0273 0.0083 3.2680 0.0016 0.0106 0.0440 0.0106 0.0440
22966 60658 4 9 4391 02 44 02
X Variable 2 0.0123 0.0007 1653.1 1.08E- 0.0108 0.0138 0.0108 0.0138
16476 45016 82 25 3021 03 3 03

46
Case – 2

Mutual fund flows Regressed with First Pd. Lag

Regression Statistic
Multiple R 0.9758806
R square 0.9523429
Adjusted R Square 0.9516522
Standard Error 7012.1077
Observations 71

ANOVA
df SS MS F Significance F
Regression 1 6.78E+10 6.78E+10 1378.841533 2.43589E-47
Residual 69 3.39E+09 49169655
Total 70 7.12E+10

Coefficie Standard t Stat P-value Lower Uppe Lower Upper

nts Error 95% r 95.0% 95.0%
95%
Intercept -227.53 3470.749 -0.0 0.94792 -7151. 6696. -7151. 6696.
224 6556 0016 48468 42 48 42
X Variable 1.0129809 0.078 37.13 2.43589 0.95855 1.067 0.9585 1.0674
1 276 E-47 8876 403 59 03

Mutual Fund Flows Regressed with First and second Pd. Lag

Regression Statistic
Multiple R 0.9768559
R square 0.9542474
Adjusted R Square 0.9528816
Standard Error 6956.5165

47
Observations 70

ANOVA
df SS MS F Significance F
Regression 2 67624409737 3.38E+10 698.6986 1.33E-45
Residual 67 3242339188 48393122
Total 69 70866748925

Coeffic Standa t Stat P-value Lower Upper Lower Upper

ients rd 95% 95% 95.0% 95.0%
Error
Intercept 1092.0 3593.7 0.3038 0.7621 -6081. 8265.1 -6081. 8265.1
073 24093 65 72 1 13 1 13
X Variable 1 1.2076 0.1206 10.011 6.13E- 0.9668 1.4483 0.9668 1.4483
155 25656 27 15 46 85 46 85
X Variable 2 -0.208 0.1267 -1.643 0.1049 -0.461 0.0446 -0.461 0.0446
2706 30852 41 84 23 85 23 85

Mutual Fund Flows Regressed with first, second and third Pd. Lag

Regression Statistic
Multiple R 0.977602
R square 0.955706
Adjusted R Square 0.952662
Standard Error 6941.881
Observations 69

48
ANOVA
Df SS MS F Significance F
Regression 3 6.76E+10 22528288648 467.4916758 6.46E-44
Residual 65 3.13E+09 48189710.77
Total 68 7.07E+10

Coeffic Standard t Stat P-value Lower Upper Lower Upper

ients Error 95% 95% 95.0% 95.0%
Intercept -532. 3743.963 -0.142 0.88731 -800 6944.5 -8009. 6944.5
613 259 06 5423 9.82 93 82 93
X Variable 1.2353 0.123008 10.0425 7.52364 0.9896 1.4809 0.98965 1.4809
1 13 5569 E-15 5 77 77
X Variable -0.402 0.191439 -2.1036 0.03927 -0.78 -0.02 -0.7850 -0.02
2 73 9404 9131 506 04 6 04
X Variable 0.1813 0.129052 1.40526 0.16470 -0.07 0.4390 -0.076 0.4390
3 52 5435 396 638 86 38 86

Mutual fund Flows Regressed with First, second Pd. Lag and FII Flows

Regression Statistic
Multiple R 0.977289121
R square 0.955094027
Adjusted R Square 0.953052846
Standard Error 6943.866204
Observations 70

ANOVA
df SS MS F Significance F
Regression 3 6.77E+10 2.26E+10 467.912552 2.15257E-44
Residual 66 3.18E+09 48217278
Total 69 7.09E+10

Coeffic Standard t Stat P-value Lower Upper Lower Upper

ients Error 95% 95% 95.0% 95.0%
Intercept 1878.6 3655.851 0.5138 0.60905 -5420. 9177.8 -5420. 9177.8
72334 81 1489 46763 12 47 12

49
X Variable 1.2052 0.120426 10.007 7.31125 0.96477 1.4456 0.96477 1.4456
1 1463 94 E-15 5143 5 5 5
X Variable -0.218 0.129821 -1.72 0.08984 -0.4715 0.0348 -0.471 0.0348
2 32386 151 2451 3011 82 53 82
X Variable 0.3502 0.314023 1.1155 0.03680 -0.2766 0.9772 -0.276 0.9772
3 93572 01 8119 742 61 67 61

50