Herding Behaviour (Indian Markets)
Herding behaviour in investing described the tendency of investors to mimic the actions of a larger group — buying what others were buying and selling what others were selling — irrespective of their own independent information or analysis, a pattern documented in FII flow clustering, retail momentum chasing, and sectoral allocation waves in Indian mutual fund data.
Herding in financial markets arose from two distinct mechanisms. Rational herding occurred when individuals, observing actions of others, inferred that others possessed superior information and updated their own beliefs accordingly — a Bayesian information cascade. Irrational or sentiment-driven herding occurred when social pressure, fear of standing out, or career risk (for fund managers) led to mimicry even in the absence of an information rationale.
For retail investors in India, herding was observable in patterns such as concentrated investments in recent top-performing sectors immediately before their correction. BSE and NSE data on MF net inflows by category showed that sectoral and thematic funds — infrastructure funds in 2007, technology funds in 2021, PSU funds in 2023 — received peak inflows near period highs, as investors herded into what had recently worked. Each of these concentrated sectoral surges historically preceded periods of below-average sector returns.
FII herding was documented in academic research using SEBI monthly FII flow data. Studies found significant serial correlation in FII net equity flows — periods of strong buying were followed by further buying, and selling cascades showed similar persistence — consistent with institutional herding or momentum following. Part of this reflected benchmark-driven behaviour: FIIs managing against MSCI EM index benchmarks bought India when the index weight rose and sold when it fell, creating mechanical flow clustering.
Mutual fund herding in Indian data was studied using overlap in quarterly portfolio disclosures. Research showed that equity fund managers showed significantly higher-than-random stock selection overlap, with popular large-cap names featuring in the top-ten holdings of dozens of funds simultaneously. While partly reflecting genuine fundamental consensus on high-quality businesses, the degree of overlap exceeded what fundamental convergence alone could explain, suggesting herding incentives.
For fund managers, career-risk herding was a recognised dynamic. A manager who underperformed while holding consensus positions suffered career consequences less severe than one who underperformed with unconventional positions. This asymmetry created rational incentives to herd around consensus, even at the cost of alpha generation. SEBI and AMFI encouraged differentiation through risk-adjusted performance metrics and tracking error disclosure as part of total expense ratio and portfolio analysis frameworks.