Foreign Portfolio Investment (FPI): Definition, Benefits, Risks, and Examples
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Summary:
Foreign Portfolio Investment (FPI) involves holding financial assets from a country outside of the investor’s own. It encompasses securities such as stocks, ADRs, GDRs, bonds, mutual funds, and exchange-traded funds. Unlike Foreign Direct Investment (FDI), FPI entails passive ownership, with investors lacking control over ventures or direct ownership of property or a stake in a company. FPI offers liquidity and a quicker return on investment but carries risks of volatility and economic disruption if withdrawn abruptly.
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Understanding foreign portfolio investment (FPI)
Portfolio investment involves making and holding passive investments in securities, aiming to earn a return. In the context of foreign portfolio investment, these securities encompass stocks, American Depositary Receipts (ADRs), Global Depositary Receipts (GDRs), bonds, or other debt issued by foreign entities, and investment vehicles like mutual funds or exchange-traded funds (ETFs) that invest internationally.
An individual investor seeking opportunities outside their own country typically engages in FPI. At a macro level, FPI contributes to a country’s capital account and reflects in its balance of payments (BOP), measuring the flow of money between countries over a fiscal year.
FPI vs. Foreign Direct Investment (FDI)
Unlike FPI, where investors have no active management over investments, Foreign Direct Investment (FDI) involves purchasing a direct interest in a foreign business. For instance, an investor from New York might buy a warehouse in Berlin to lease to a German company, aiming for long-term income.
FDI investors typically exert control and actively manage the invested company, contributing to its growth and monitoring their return on investment (ROI). However, FDI entails less liquidity and greater risks, including currency exchange and political instability, compared to FPI.
Example of foreign portfolio investment (FPI)
In 2018, India experienced significant FPI activity, with over 600 new investment funds registering with the Securities and Exchange Board of India (SEBI), bringing the total to 9,246. Factors such as a favorable regulatory environment and strong performance of Indian equities in preceding years fueled foreign investors’ interest.
Frequently asked questions
What types of securities are involved in foreign portfolio investment?
Foreign portfolio investment can include stocks, American Depositary Receipts (ADRs), Global Depositary Receipts (GDRs), bonds, mutual funds, and exchange-traded funds (ETFs) invested in assets abroad.
What distinguishes foreign portfolio investment from foreign direct investment?
Foreign portfolio investment involves passive ownership of financial assets, with investors lacking control over ventures or direct ownership of a company. In contrast, foreign direct investment entails purchasing a direct business interest in a foreign country and often involves active management of the invested company.
How does foreign portfolio investment affect a country’s economy?
Foreign portfolio investment can affect a country’s economy by providing additional capital, contributing to liquidity in financial markets, and influencing exchange rates. However, sudden withdrawals of FPI during economic downturns can lead to currency depreciation and financial instability.
What are the main risks associated with foreign portfolio investment?
The main risks of foreign portfolio investment include volatility in financial markets, currency exchange rate fluctuations, political instability in foreign countries, and regulatory changes affecting investment returns.
Key takeaways
- Foreign portfolio investment (FPI) involves holding financial assets from a foreign country.
- FPI encompasses stocks, ADRs, GDRs, bonds, mutual funds, and ETFs.
- Unlike FDI, FPI entails passive ownership and offers liquidity.
- FDI involves direct investment in a foreign business and often entails active management.
- FPI is more suitable for retail investors, offering liquidity and a quicker return on investment.
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