If you have come across the term “foreign portfolio investment” or FPI in any economics or stock market article, you may be wondering what exactly it is? This article will help you understand the concept of foreign portfolio investment.Read more
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In simple language, foreign portfolio investment (or FPI) is the means for investors to invest in financial assets or securities outside their country. Typically, they include equity stocks, government bonds, mutual funds, and exchange-traded funds. Apart from individual investors, FPIs are also made by foreign companies and even governments.
FPIs show healthy growth mostly in growing and emerging economies where investors can hope for better growth in their investment portfolio. Along with foreign direct investment (FDI), FPI is commonly used to invest in any overseas country and acts as a reliable source of income for many countries.
Additionally, FPI is a good indicator of the stock market performance in any country and shows the level of participation from foreign investors.
FPI is a passive form of investment where a foreign investor simply holds financial assets. The investors do not manage the investments made by the company whose assets they may be holding – neither do they have any control over the business assets. For this reason, FPI investors face higher risks in the form of share price volatility.
On the other hand, FDI is a form of investment where foreign investors have a direct business stake or interest in their foreign assets. For example, a foreign investor in China could directly purchase a manufacturing unit or warehouse facility based in New York City. The investor can also choose to expand its operations or lease it to a third-party company.
In FDI, foreign investors have higher control over managing their purchased assets and can choose to build the business over a longer term for higher returns on their investment.
While FPI is more volatile than FDI, it offers higher liquidity and higher short-term returns. Using FPI, foreign investors can quickly invest their capital into any emerging economy – and withdraw their investments in the event of an economic downturn or political uncertainty emerging in that country.
For retail investors, FPI is a more convenient mode of investing in offshore financial assets. On the other hand, FDI is suitable for institutional investors and individuals (with high net worth) and companies. FDI investors can also choose to invest in FPIs.
How does FPI benefit both its investors and companies? Let us discuss a few benefits, including:
The golden rule of investment is “not to put all your eggs in one basket.” Foreign investors can use FPI to diversify their investment portfolio and achieve higher returns. With a diversified portfolio, investors can experience lesser volatility (occurring in any one financial market) and increase their chances of booking higher profits.
Effectively, FPI provides foreign investors with increased credit in other countries, boosting their credit base. For example, investors with a low domestic credit score can compensate their losses with a higher foreign credit score. This provides higher leverage to investors to earn better returns on their foreign equity investment.
Thanks to FPI, retail investors no longer need to invest only in the 'domestic' financial market. They can now increase their reach to the wider global market and earn better returns (due to more investment opportunities). Further, some countries may have an emerging or "unsaturated" investment market, increasing returns on investments.
Compared to long-term FDIs, the FPI mode improves the liquidity of individual investors and domestic capital markets. With more liquidity, financial markets can grow and finance a wider range of investment opportunities. At the same time, investors have more control over their investment portfolio and can quickly sell their foreign assets whenever they see any significant risk or need more cash.
FPI boosts the demand for company equities and other assets, thus enabling companies to raise easy capital at lower costs. With FPI, any company now has access to global investors and overseas companies.
Along with benefits, investors also have their share of risk factors, including the following:
A sudden change in the political climate or environment can create future uncertainty for investors, including foreign investors. For example, a change in government could result in changes in economic or investment policies, which could impact FPI investors.
Foreign investors prefer to invest in countries with a stable currency. A constantly changing currency exchange rate can discourage foreign investors from investing in any country. At the same time, a sudden increase (or decrease) in the invested FPI capital could also impact the prevailing exchange rate.
Along with the currency exchange rate, volatility or fluctuations in the asset price can be another major risk factor. For example, the Germany-based DAX index has been historically more volatile than the U.S S&P 500 index.
Based on the risk profile of the investments, there are primarily three categories of FPI in India, which are:
Category I (or low risk) comprises financial assets backed by the Indian government (or government agencies like the central banks). For example, a sovereign wealth fund, government bonds, or any fund owned by the Indian state.
Category II (or moderate risk) comprises mutual funds, pension funds, insurance policies, and bank deposits.
Category III (or high risk) includes all FPIs not covered under the first two categories. For example, charitable trusts or endowments.
To be eligible for FPI in India, the applicant must not be a resident of India nor a non-resident Indian (or NRI).
Additionally, they must not be the citizens of any country listed under FATF (or the Financial Action Task Force). Further, FPI applicants must belong to any country signatory to the International Organization of Securities Commission.
As a guideline, foreign investors must consider investing in FPIs in emerging economies or countries that offer higher growth than the investor’s resident country.
Additionally, they should consider stock markets with a history of good performance and returns to their investors. Further, investors must consider the economy of the host country and its current growth path before investing.
In summary, foreign portfolio investments (or FPIs) are an efficient form of investment for foreign investors looking to diversify their portfolios to a foreign country. As we have seen, FPIs have higher liquidity for investors as compared to long-term FDI.
We hope this article has helped you understand foreign portfolio investment along with its benefits and risk factors. With all this information, you can decide if investing in an FPI is the right one or not. However, you must talk to a professional before investing or carryout your in-depth analysis of the fund.
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