The Role of Domestic Investors in Shaping Market Index Returns

Domestic investors drive dynamic market index returns.

Domestic investors, comprising both institutional and retail participants, have significantly influenced market dynamics. Their activities shape demand, supply, and overall market sentiment. Domestic Institutional Investors (DIIs) like mutual funds, pension funds, insurance companies, and banks have injected stability and liquidity, countering the volatility often caused by Foreign Institutional Investors (FIIs). With advancements in technology, regulatory reforms, and increasing financial literacy, retail investor participation has also surged, transforming the market landscape.

Understanding Domestic Institutional Investors (DIIs)

DIIs are entities operating within a country’s financial system. They invest in securities and other financial assets influenced by domestic political and economic factors. Key types of DIIs include:

1. Mutual Funds: By pooling resources, mutual funds invest in diversified securities, minimizing risk while targeting high returns. India’s mutual fund industry has grown exponentially, with Assets Under Management (AUM) rising from ₹8.25 lakh crore in FY 2014 to ₹53.40 lakh crore in FY 2024, and projections suggest it may surpass ₹100 lakh crore soon.

2. Insurance Companies: These entities accumulate assets through premiums and invest in stocks, bonds, and real estate under regulatory guidelines. Indian insurers collectively manage over ₹60 lakh crore in assets.

3. Pension Funds: These funds manage retirement savings, aiming for long-term capital appreciation and income generation through equities, fixed-income securities, and alternatives.

4. Banks and Financial Institutions: Banks and financial institutions invest across markets to generate returns, contributing to both short- and long-term financial obligations.

Contributions of Domestic Investors

1. Diversification Across Sectors: DIIs distribute investments across sectors, balancing economic development and mitigating risks.

2. Enhancing Market Liquidity and Confidence: By buying and selling securities, DIIs ensure market liquidity and consistency, fostering investor confidence.

3. Promoting Market Stability: DIIs’ long-term investment strategies reduce volatility, supporting market indices during both bullish and bearish phases.

4. Countering FII Volatility: FIIs, influenced by global factors, often cause market swings. DIIs act as a stabilizing force, purchasing undervalued stocks during foreign capital outflows.

5. Driving Economic Growth: DIIs’ investments are guided by economic analysis, channeling funds to sectors that drive progress and development.

Retail Investors’ Growing Influence

India has experienced a paradigm shift with a dramatic rise in retail investor participation. Demat accounts have surged to over 15 crore, reflecting changing saving patterns. Traditional methods like fixed deposits are now complemented by equity and mutual fund investments.

1. Market Growth: The National Stock Exchange’s market capitalization rose from $2 trillion in 2017 to $5 trillion in 2024.

2. Changing Demographics: Millennials now dominate, with the proportion of young investors increasing significantly. Demat accounts grew from 4 crore in 2020 to 14 crore in 2024.

3. Equity Mutual Fund Inflows: Retail investor-driven inflows provide consistent capital, mitigating volatility from FII movements, as seen during the COVID-19 pandemic.

Growth Drivers:

• Regulatory Support: SEBI initiatives enhance transparency and investor protection.

• Technological Advancements: Platforms like Zerodha and Groww simplify investing.

• Simplified KYC Processes: Aadhaar-based e-KYC reduces entry barriers.

• Financial Literacy: Education empowers informed decision-making.

• Tax Incentives: Schemes like ELSS encourage mutual fund investments.

Challenges for Retail Investors

1. Limited Awareness: Many retail investors lack knowledge of effective investment strategies.

2. Rural Participation: Greater efforts are needed to extend financial services to rural areas.

3. Market Volatility: Educating investors about risk management is essential.

4. Technology Adoption: Innovations like T+1 settlement cycles and secure depositories have improved accessibility and reliability.

Interaction Between Domestic and Foreign Investors

The interplay between DIIs and FIIs is crucial. FIIs contribute to market liquidity but often induce volatility due to external factors. For instance, during the financial crisis of 2008, sharp FII outflows caused market instability. Conversely, in FY 2018–19 and FY 2021–22, despite significant FII outflows, strong domestic inflows sustained positive market returns of 17.30% and 18.29%, respectively. DIIs and retail investors’ consistent participation ensured market resilience.

Conclusion

Domestic investors play a pivotal role in stabilizing and growing India’s financial markets. DIIs counteract FII-driven volatility, while retail investors bring vibrancy and long-term growth. Historical trends highlight the importance of strong domestic inflows in maintaining market stability. With continued regulatory, technological, and educational advancements, India’s financial ecosystem is well-positioned for robust and sustained development.

Thank you

Regards,

Saumya Shah

Kautilya, IBS Mumbai.