The value of participatory notes in the stock market grew 70 per cent in just one year between January 2006 and January 2007, accounting for over one-third of total foreign portfolio investments in the Indian stock markets, according to government estimates.

But contrary to conventional wisdom, the share of hedge funds in total PN investments in the Indian stock markets could be as little as 8-9 per cent.

Earlier estimates put hedge funds' share at 70-80 per cent of total PN investments, which formed the basis of demands for a ban on this instrument.

PNs are offshore derivative instruments issued by foreign institutional investors to unidentified overseas investors who are not eligible to invest directly in Indian stocks.

The Reserve Bank of India, the Securities and Exchange Board of India and the finance ministry are divided in their opinion on the wisdom of allowing the use of the instruments (see chart).

The RBI has criticised PNs, which do not require fund source disclosures, terming them a conduit for money laundering by Indian companies and for hedge funds, which are not permitted to trade on the Indian bourses.

Hedge funds, in particular, which are known for their quick entry into and exit from stock markets, were blamed for the high volatility of Indian stock prices ever since the 2,000-point crash of the benchmark Sensex in May 2006.

The latest statistics suggest that the suspicions about hedge funds might be misplaced.

Rajeev Baddepudi, senior analyst with Eurekahedge, a Singapore-based hedge fund tracking outfit, told Business Standard that the total assets under management by 35 India-specific hedge funds that could be identified stood at $2.5 billion.

"If you consider that many of these funds are leveraged by 1.5 to 2 times, the total assets invested by them in the Indian markets could go up to $3.5-4 billion," he said over the phone from Singapore.

Investments by registered FIIs in India since the early '90s is $52 billion at cost price and $119 billion at market price, according to Sebi. Going by Sebi's own estimates that PNs constituted about 34 per cent of the foreign portfolio investments in India, the total value of PNs could be as high as $41 billion.

There are about 1,000 FIIs registered in India, but only 10-15 of them, such as Merrill Lynch, Morgan Stanley and Goldman Sachs, are active in the PN segment.

Hedge funds also invested in other asset classes including real estate and not just equities, said Baddepudi, hinting that their involvement in Indian stock markets could be much less than what was perceived earlier.

FIIs invested a total of $8.5 billion in 2004, $10.7 billion in 2005 and $8 billion in 2006.

In the current calendar year, FIIs have invested just over $3 billion in the equity markets.

In September 2003, PNs constituted 26 per cent of total FII inflows, rising to up to 35 per cent in February 2005.

"PNs constitute just over 30 per cent of the total FII investments. But the amount is bigger as growth is from the bigger base," a Sebi official pointed out.