DIIs to blame for midcap carnage: IIFL's Nirmal Jain

"FIIs have invested USD 8.5 billion in India this year and DIIs have sold around USD 4 billion dollars this is offsetting the impact of foreign fund inflow and increasing our dependence on FIIs," adds Jain.

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According to Jain, sharp volatility seen in midcap share price is because FIIs keep switching money from large cap stocks to sectors.

"The midcap space is becoming very shallow in terms of depth and breadth of holding and trading, therefore there is an increased volatility in these stocks," he adds.

A dramatic fall in the share prices of about a dozen mid-cap stocks was seen last week pulling down the Indian indices drastically. Last year July, a similar crash was witnessed in midcaps in a single day, leading to a Sebi probe into the sell-off.

The structural problem with most midcap stocks is that there are no buyers from mutual funds and insurance companies even for well run companies, he points out.

Below is the verbatim transcript of Nirmal Jain's interview on CNBC-TV18

Q: What do you think are we about to see next? This year has not been very good so far. Do you think we have a near-term support around 5700-5600 or are we staring at a deeper correction?

A: It will depend on how news events take place from hereon in terms of credit rating, global turbulence. In this year, if you really look at the liquidity which has been the driver of the market then foreign institutional investors (FIIs) poured in about USD 8-8.5 billion and our domestic institutional investors (DII) i.e. mutual funds and insurance companies sold about USD 4-4.5 billion. Another USD 4-4.5 billion has come from the offer for sale (OFS) from government and promoters trying to bring their stakes down to 75 percent.

One key problem with our market today is the lack of participation of local investors - retail investors, high networth individuals (HNI) or mutual funds and insurance. In mutual funds and insurance, there has been continuous outflow. Therefore, market is depending on FIIs and FIIs are chasing large caps and certain sectors. So, the midcap is becoming hollow and shallow in terms of depth and breadth of holding and trading and therefore, you see very volatile movements. In this year, what we have seen in midcaps the broader indices do not reveal the actual picture, but the midcap indices are down by 17-18 percent YTD which is dramatic in two months time.

It does not look like we are in a bull market and the problem is that when they say that there is a funding against four-five stocks and goes beyond the margin call, you sell one stock to make up for that entire thing. If one stock falls because of pledged shares, then a broker will end up selling all five stocks or partly all five stocks and that causes the panic and cascading impact.

The problem is that there are no buyers for mutual funds and insurance companies from midcap and small cap even when the stocks are good and well run companies. This is a structural problem which will have a long-term solution as well as long-term implication. It is not something that can be visualised for any solution overnight. So, we are looking at volatile midcaps, small caps even if FII money continues to flow in.