Foreign portfolio investors are believed to play an important role in deciding the direction of the market. If the perception that they have the power to move the market is true, this power can be used by them to manoeuvre the market to their own benefit and to profit at the cost of other investors. Therefore, the profitability of the transactions of foreign institutional investors (FIIs) have important policy implications. This study examines the market timing skills of FIIs as a group. We simulate investment portfolios replicating the patterns of transactions made by FIIs, and compare the profitability of these portfolios with the profitability of simulated portfolios following two passive investment strategies viz., the buy-and-hold strategy and systematic investment strategy. We have also simulated the portfolios replicating the patterns of transactions made by domestic institutional investors (DIIs) and investors of other categories (which mainly comprise individual investors), and the profitability of FIIs’ portfolio is also compared with the profitability of the portfolios representing these categories of investors.
Using the daily patterns of aggregate net investment by FIIs and DIIs, we have constructed portfolios to replicate the trading strategies of FIIs, DIIs and investors of other categories. The performance of these portfolios has been evaluated on the basis of their modified internal rate of return, both, in terms of the Indian Rupee and the US Dollar. Based on a large number of block-bootstrap samples, we observe that the average return of the portfolio representing FIIs’ investment strategy is significantly lower than average returns of benchmark portfolios. Similarly, the average returns of portfolios replicating FIIs’ trading strategy are not higher than returns of portfolio replicating investment strategy of DIIs and other investors. The average returns of an investor following FIIs’ trading strategy with respect to 42 individual securities are also not found superior to the returns on two benchmark strategies. Therefore, our results suggest that the FIIs do not have superior market timing skill.
