Many investors quickly learn to appreciate the significance of institutional investors – the mutual funds, pension funds, banks and other big financial institutions. These type of investing entities are often referred to as “smart money” and are estimated to account for as much a huge chunk of all trading activity. This professional stock buying is called institutional sponsorship and is believed by many stock watchers to send a strong message about a company/markets’ health and financial future. It is for this reason that some investors believe that companies with institutional support carry less risk and thus make good investments. They choose therefore to mimic their moves in the market with the hope of profiting. But does this strategy work?
Looking at the Capital Markets Authority (CMA) quarterly 2015 report, it shows a poor track record following institutional investors. Here are few instances: when foreign institutional investors (FIIs) decreased their total equity holdings at the Nairobi Securities Exchange (NSE) to 26.3 per cent in 2005, down from 29.8 per cent, that year the market gained 50.5%, higher than 36.4 per cent gained in the previous year. Likewise, in the following year, when FIIs further culled their positions to 25.6 per cent, the market rallied 7.3 per cent. In 2007, the same thing continues. The market rallied 27.8 per cent in that year as foreign institutions cut down their positions again to 18.6 per cent. Mimicking these moves would have returned investors lesser than the cumulative gain of 106 per cent in the three years.
Interestingly, the same thing happens with following domestic institutional investors (DIIs). In 2008, when this group upped their market positions to 77.2 per cent of the total equity holdings, the market dropped more than a third of its value.
It is the legendary investor, Peter Lynch, who said that institutional investors make poor role models for individual investors. In his best-selling book “One Up on Wall Street”, he listed thirteen characteristics of the perfect stock and one of them stated that; “If institutions don’t own it and the analysts don’t follow it”.
Although statistics show that institutional sponsorship is a good indicator of a good company, investors should be aware that institutional investing is not always driven by quality fundamentals. Besides, it retail investors forget that FIIs and DIIs have their own parameters for taking investment decisions. If FIIs are facing a liquidity crunch they may sell even good stocks to raise money. In this case, a retail investor who follows FIIs/DIIs and sells the stock may miss the chance to make money. This often happens because the risk appetite, investment horizon as well as the holding power of retail investors are different from that of institutional investors.
Again, what retail investors need to consider is; what may look like a huge stake may be a minuscule portion of the institutional portfolio. So, these investors can afford dump a few stocks any time without a big impact on their overall portfolio. In all, investors should always do their own homework and not follow blindly.