Foreign Portfolio Investment - Definition, Examplse, Pros and Cons of FPIs (2024)

You may have often heard about the acronym FPI in stock market news or while reading business newspapers. So, what is foreign portfolio investment exactly? It is a method of investment that allows the investor to hold significant assets in a foreign country. In most cases, an FPI comprises several types of assets including bonds, stocks, and ‘cash equivalents’. Cash equivalents may include Government-issued Treasury and Savings Bonds, T-Bills, Marketable Securities, and ‘Money Market Funds’.

FPI and Foreign Direct Investment

Together with FDI or Foreign Direct Investment, FPIs present one of the easiest ways to invest in a foreign country. Unlike FDI, the investor does not have direct access to, or control over, the assets of the company in which they have invested. FPIs are thus categorised as indirect and hands-off investment techniques meant solely for greater returns.

Outside the boundaries of theoretical concepts, both FPIs and FDIs are essential for a country’s economy. India, currently the world’s 6th largest economy in terms of nominal GDP in 2020, is ideally suited for more portfolio investors as it has witnessed steady growth ever since liberalisation in 1990.

Besides, Indian stock markets have recovered better than equivalent institutions in other countries. There are fewer chances of market volatility as jobs pick up, and the economy opens up. These factors, plus a stable Government at the Centre, ensure that market volatility is pretty low and hence foreign portfolio investment in India remains an area to explore for many novice investors.

Understanding FPIs Better

Unlike Foreign Direct Investments, portfolio investors do not wish to gain control of a company. Their primary aim is speculative profit. Around the world, the biggest and growing economies receive the largest chunks of investments via the FPI route because of a couple of reasons –

• A stable economy ensures that the speculation on the part of an investor pays off well. There are several factors that come together and form a dynamic economy. These include budgetary provisions, investment laws, taxation benefits, treaties with other countries on trade, etc.

• Most Foreign Portfolio Investors will look to invest in countries that have a stable Government, a well-rounded bureaucracy, and a diversified market. All these factors reduce the element of risk. The high liquidity of Foreign Portfolio Investment means that a lower risk factor is a crucial pre-requisite.
• Developing or evolving countries like India and Brazil attract a sizeable amount of indirect investments via FPIs each year. India’s market is largely untapped and holds enormous potential. The Indian Government has already framed rules including merging NRI investment routes with FPIs and allowing the purchase of listed debt securities.

That means foreign investors can now buy securities in such high-value government-backed entities like the Real Estate Investment Trusts (REITs) besides Infrastructure Investment Trusts (or InvITs).

There are several other aspects of Financial Portfolio Investment. A steady inflow of such investments indicates a robust stock market. Global analysts follow these developments with care as they signify the current economic status of a country.

Finally, FPIs offer investors the freedom to diversify their portfolios internationally. A portfolio investor can also take advantage of exchange rate differences. Thus, an investor from an economically challenged country can invest heavily in a foreign country that has a much stronger currency, thereby making sizeable profits.

FPIs vs FDIs: A Detailed Comparison

There are several substantial differences between these two channels of foreign investments. The major ones are as follows –

1. An FDI, by default, establishes a tangible and direct business interest in the target country. This ‘interest’ could be anything from a single warehouse to managing a company remotely. An FPI does not entail any such hands-on business interest. It is a passive form of investing.
2. Unlike FDIs, a Financial Portfolio Investment does not require any transfer of IP, technology, or know-how. There is no need to enter a joint venture with a partner company.
3. It has been noted that Foreign Direct Investments comprise significantly larger sums and any tie-ups or operations tend to last longer than portfolio investors.
4. Lastly, FDIs are usually the domain of major players in the industry, venture capital ecosystems, and investment branches of globally-recognised financial institutions. Most Financial Portfolio Investment examples include smaller players who invest in a foreign country’s assets and securities for short-term profits.

Recent Foreign Portfolio Investment Examples in India

• According to the latest figures available publicly, FPIs have regained their confidence in the Indian economy after months of lockdowns, job losses, erosion of funds, and stock market disappointments.
• Between November 2nd and 6th 2020, FPIs have pumped in around Rs. 8,381 crores in India’s markets, a clear indication that most investors believe India’s economic recovery will be faster than most western countries.
• The equity segment received just above Rs. 6,000 crores while the rest went into debt segments.
• This influx of funds was a marked departure from October 2020 when most Foreign Portfolio Investment entities were net buyers. A weak US dollar has also helped in restoring investor confidence.
• If the current trend continues, India may soon become the preferred destination for portfolio investors.

Pros and Cons of FPIs

FPIs have several benefits and downsides. The most common ones include the following –

India will receive a significant portion of funds via FPIs. It is believed that all investments will be sector-agnostic. The RBI’s and the Finance Ministry’s recent steps will also help India become an investment hotspot in an otherwise lackadaisical scenario.

Various FPI Categories in India

Following are the primary three categories of FPI in India-

Category I (or low risk)– This contains financial assets backed by the Indian government. Examples are government bonds, any fund owned by the Indian state, a sovereign wealth fund, etc.

Category II (or moderate risk)– This includes bank deposits, mutual funds, insurance policies, pension funds, etc.

Category III (or high risk)– This comprises all such foreign portfolio investments that are not covered under the first two categories. Like, charitable trusts or endowments.

Frequently Asked Questions on FPI

Ques. Who Can Make FPI?

Ans. Foreign portfolio investing has become popular and a lot of investors are becoming a part of it. Foreign portfolio investments are usually made by:

• Individuals
• Companies
• Foreign governments

Ques. Why is foreign portfolio investment important?

Ans. Foreign portfolio investment holds great importance as it gives investors an opportunity to explore international diversification of their portfolio assets, which in turn can help achieve a higher risk-adjusted return. Moreover, this also means that when an investor has stocks invested in different countries will experience less volatility over the entire portfolio.

Ques. What are the two types of FDI?

Ans. FDI can be categorized into two types- Horizontal and Vertical. However, there are two other types of foreign direct investments that have emerged, viz. conglomerate and platform FDI.

Ques. Which country sees the highest foreign direct investment?

Ans. The United States is the largest recipient of FDI by far, with inflows of $251 billion, followed by China having flows of $140 billion and Singapore with $110 billion.