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In the stock market, institutional investors play a significant role in influencing its dynamics. They are considered experts in investing large amounts of capital in various financial instruments on behalf of their clients. Institutional investors are highly sophisticated and use advanced technology and tools to develop their financial models. Their scale of trading and investing is much larger than that of retail investors. In this blog, we will categorise institutional investors as Foreign Institutional Investors (FIIs) and Domestic Institutional Investors (DIIs) to understand their role in the stock market better.
Table of Contents
Categories of Institutional Investors
Domestic Institutional Investors
- DII are significant market players in the financial landscape. Each of their market moves influences the financial markets, representing their substantial role.
- They are domestic entities that invest in domestic markets and financial instruments. They pool money from domestic sources and invest those in different domestic sectors on behalf of their clients.
- DIIs encompass various entities such as mutual funds, hedge funds, insurance companies, and other financial institutions.
- DIIs ensure regulatory compliance so as to ensure transparency and fair market practices.
Foreign Institutional Investors
- FIIs are key market influencers influencing market liquidity and stability alongside DIIs and retail investors.
- These are financial institutions based outside of India that invest in the Indian stock market and other financial instruments.
- The Securities and Exchange Board of India (SEBI) regulates the investment activities of FIIs, which are subject to certain restrictions and guidelines.
DII Vs FII
| Basis | Domestic Institutional Investors | Foreign Institutional Investors |
| Investor Origin | Investors are based in India and invest in domestic markets and assets. | Investors are based globally and are making investments in Indian markets. |
| Investment Style | DII typically focus on long-term investments in diverse sectors of the economy. | FII typically invest in a few sectors that are likely to generate returns within a short to medium-term horizon. |
| Investment Regulations | DII are not subject to investment limitations. | FII can invest only up to 24% of the total paid-up capital of the company they are investing in. |
| Influence | They are influenced by domestic factors such as government policies and domestic market trends. | Global factors and the political stability of the economy influence them. |
| Impact on Market | DII’s consistent presence in the market leads to stability in the financial markets. | FII’s capital inflows and outflows cause market volatility and liquidity. |
DII and FII: Impact on the Indian Stock Market
Affects Liquidity
- The market performance of DII and FII significantly affects liquidity in financial markets.
- When these investors actively participate in the stock market, there is a steady inflow of capital, which helps to bridge any capital gaps in the market and subsequently increases the overall liquidity of the stock market.
- However, FIIs have a higher contribution to market volatility and liquidity than DIIs as DIIs are more investment-oriented while FIIs are trading-oriented.
Market Equilibrium
- DII and FII are influenced by different factors and, hence, move in opposite directions at times. It has been noticed that when FIIs go up, DIIs go down, and when FIIs go down, DIIs go up.
- FIIs are known to be sellers, while DIIs are known to be buyers in the Indian stock market. FIIs usually invest in short-term and medium-term investments and tend to sell their holdings when they predict unfavourable market conditions. During this time, DIIs play a crucial role in stabilising the market by investing in various asset classes at lower prices for the long term, bringing investor confidence back into the stock market. Therefore, DIIs are considered buyers who help maintain market stability.
- The market performance of both DII and FII maintains a healthy market equilibrium and prevents market crashes.
Attracts New Domestic and Foreign Investors
- The Indian stock market attracts new domestic and foreign investors due to the sectors and asset classes in which DII and FII invest.
- As FIIs seek out efficient and emerging markets with growth potential, the presence of more FIIs in the market has a positive influence on other FIIs. Retail investors also take note of DII investments as they serve to build investor confidence.
- Furthermore, DII and FII have a mutually beneficial relationship and positively impact each other.
Economic Growth and Development
- DIIs and FIIs heavily drive the Indian stock market. They both add to the growth and development of emerging markets and underrated sectors of the economy.
- Both are co-dependent even though their investment pattern varies. They play a vital role in the growth of the Indian stock market and the economy as a whole.
- They contribute to internal market stability, liquidity, and investor confidence, maintaining a healthy market environment that strengthens the economy’s base.
Impact on Market Trends
- DIIs and FIIs are like two wheels of the Indian stock market. The stock market can not function without one of them missing.
- They shape market trends and market sentiments.
- When FIIs are bullish and pump capital into the market, it indicates an uptrend in the market. However, large-scale selling suggests a downward trend.
- DIIs serve as a counterbalance to FII-induced volatility. They may continue to invest in the stock market, preventing the market crash.
Conclusion
An economy that is developing and emerging, like India, requires a healthy interplay between foreign institutional investors and domestic institutional investors. This interplay ensures a healthy stock market environment, which plays a crucial role in developing a dynamic economy that attracts opportunities for growth.
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