Securities and alternative foreign financial assets that are passively held by a foreign investor
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Foreign portfolio investment (FPI) involves an investor purchasing foreign financial assets. The transaction of foreign securities generally occurs at an organized formal securities exchange or through an over-the-counter market transaction.
Foreign portfolio investment is becoming increasingly more common as a means of portfolio diversification. Often, FPIs consist of securities and alternative foreign financial assets that are passively held by a foreign investor.
Summary
- Generally, foreign portfolio investments consist of securities and alternative foreign financial assets that are passively held by a foreign investor. Itinvolves an investor purchasing foreign financial assets.
- Foreign portfolio investors are normally exposed to increased share price volatility, which increases their risk, and investors expect to receive compensation for the risk they take on.
- Foreign portfolio investors can access equities, bonds, derivatives, mutual funds, and guaranteed investment certificates, among other instruments.
Who Can Make Foreign Portfolio Investments?
Foreign portfolio investing is popular among several different types of investors. Common transactors of foreign portfolio investment include:
- Individuals
- Companies
- Foreign governments
Benefits of Foreign Portfolio Investment
The primary benefits of foreign portfolio investment are:
1. Portfolio diversification
Foreign portfolio investment provides investors with an easy opportunity to diversify their portfolio internationally. An investor would diversify their investment portfolio to achieve a higher risk-adjusted return, which is ultimately done to help generate alpha.
2. International credit
Investors may be able to access an increased amount of credit in foreign countries, allowing the investor to utilize more leverage and generate a higher return on their equity investment.
3. Access to markets with different risk-return characteristics
If investors are seeking out greater returns, they must be willing to take on greater risk. Emerging markets can offer investors a different risk-return profile.
4. Increases the liquidity of domestic capital markets
As markets become more liquid, they become deeper and broader, and a wider range of investments can be financed. Savers can invest with the assurance that they will be able to manage their portfolio or sell their financial securities quickly if they need access to their savings.
5. Promotes the development of equity markets
Increased competition for financing will lead to the market rewarding superior performance, prospects, and corporate governance. As the market’s liquidity and functionality develop, equity prices will become value-relevant for investors, ultimately driving market efficiency.
Risks of Foreign Portfolio Investment (FPI)
The primary risks faced by a foreign portfolio investor are:
1. Volatile asset pricing
Across international financial markets, some are riskier than others. For example, consider the Deutscher Aktienindex (DAX). The DAX is a stock market index of 30 major German companies trading on the Frankfurt Stock Exchange. The DAX is historically more volatile than the S&P 500 Index.
2. Jurisdictional risk
Jurisdictional risk can result from investing in a foreign country. For example, if a foreign country that you were invested in drastically changes its laws, it could result in a material impact on the investment’s returns.
Moreover, many countries struggle with financial crime, such as money laundering. Investing in countries where money laundering is prevalent increases the jurisdictional risk faced by the investor.
Financial Assets for Foreign Portfolio Investments
The typical financial assets that can be purchased through foreign portfolio investment include equities, bonds, and derivative instruments. These securities can be purchased for many reasons; however, generally, foreign portfolio investment is positively influenced by high rates of return and reduction of risk through geographic diversification.
Policies for Foreign Portfolio Investment
Foreign portfolio investment is inherently volatile, and rigorously regulated financial markets are needed to manage the risk effectively. Furthermore, the financial system must be capable of identifying and mitigating risks for prudent and efficient allocation of foreign or domestic capital flows.
Economic growth and development are enabled by successful financial intermediation and the efficient allocation of credit. Financial systems can maintain their health through the identification and management of business risks. Moreover, the financial system must also withstand economic shocks.
Related Readings
Thank you for reading CFI’s guide on Foreign Portfolio Investment (FPI). To keep learning and developing your knowledge of financial analysis, we highly recommend the additional resources below:
- Emerging Market Bond Index
- Foreign Investment
- Portfolio Planning
- See all wealth management resources
- See all capital markets resources
FAQs
Foreign portfolio investment (FPI) refers to the purchase of securities and other financial assets by investors from another country. Examples of foreign portfolio investments include stocks, bonds, mutual funds, exchange traded funds, American depositary receipts (ADRs), and global depositary receipts (GDRs).
What are the pros and cons of FPI? ›
FPI Advantages include diversification, liquidity, access to growth, no management control, and foreign exchange earnings. FPI Disadvantages include Market volatility, short-term focus, lack of control, currency risk, and market distortions.
Is FPI a foreign investment? ›
Foreign Portfolio Investment (FPI) involves an investor buying foreign financial assets. It involves an array of financial assets like fixed deposits, stocks, and mutual funds. All the investments are passively held by the investors. Investors who invest in foreign portfolios are known as Foreign Portfolio Investors.
Which is more risky FPI or FDI? ›
Risk and Volatility: Consider your risk tolerance. FPI is more susceptible to market fluctuations and short-term capital flows, whereas FDI is relatively more stable due to its long-term nature.
What is FPI in simple terms? ›
Foreign portfolio investment (FPI) involves holding financial assets from a country outside of the investor's own. FPI holdings can include stocks, ADRs, GDRs, bonds, mutual funds, and exchange traded funds.
What are the disadvantages of FPI? ›
FPI disadvantages
Investors can gain substantially from exchange rate differences. Markets in any country are inherently volatile. Despite the fluid nature of FPIs, losses may pile up if funds are not withdrawn hastily.
What is the positive impact of FPI? ›
Benefits: Capital Inflow: FPI results in the inflow of foreign capital into the Indian financial markets, which contributes to increased liquidity and capital availability. Boost to Stock Market: Increased FPI can positively impact the stock market, leading to higher valuations and increased investor confidence.
What are the investment limits for FPI? ›
Investors, whether individuals or firms, need to be registered with country's markets regulator and adhere to its disclosure requirements. Most of the 10,800 FPIs are funds. There are no restrictions for investing in Indian companies via this route, however an FPI cannot hold more than 10% in a listed company.
Can FPI invest in debt? ›
Currently, only around 19 per cent of the total limit offered (in debt market) is utilised by FPIs in the Indian debt markets. However, the proposed inclusion of Indian bonds in the global indices will add buoyancy to FPI interest in the Indian debt market, economists and analysts said.
What are high risk FPI? ›
The first ones would be the FPIs which have 50% of their India Assets Under Management (AUM) in one single corporate group. The second set of FPIs identified under the 'high-risk' category would be the ones which have over ₹25,000 crore AUM in the Indian equity market.
The entities encompassed in this category include regulated asset management companies, investment funds, portfolio managers, banks, pension funds, and other regulated funds. 2. Who controls FPI in India? The Securities and Exchange Board of India (SEBI) controls FPI in India.
Why is FPI better than FDI? ›
Bottom Line. In summary, FDI represents a more substantial and enduring investment with a higher level of control, while FPI involves shorter-term investments in financial assets without seeking significant influence over the companies invested in.
How does FPI affect the exchange rate? ›
The increase in FPI in form of domestic bonds often strengthens the local exchange rate. Domestic appreciation tends to increase FPI in the bond market.
Is foreign direct investment good or bad? ›
Foreign direct investment impacts the U.S. economy in many positive ways. For example, FDI: Creates New Jobs: U.S. affiliates of foreign companies (majority-owned) employ approximately 5.3 million U.S. workers, or 4.6% of private industry employment.
Which portfolio has the most risk? ›
Equities and real estate generally subject investors to more risks than do bonds and money markets. They also provide the chance for better returns, requiring investors to perform a cost-benefit analysis to determine where their money is best held.
What are the different types of FPI? ›
Categories of FPI
- Category I (or low risk): It comprises financial assets backed by the Indian Government. ...
- Category II (or moderate risk): It comprises regulated broad-based funds like mutual funds, pension funds, insurance policies, bank deposits, etc.
The FPI full form in share market is Foreign Portfolio Investment. It is a type of investment made by foreign portfolio investors in India in the securities of a country other than their own.
What is FPI used for? ›
Fluorescent penetrant inspection (FPI) is a highly effective method for identifying surface-breaking flaws, cracks, and defects that might otherwise go unnoticed. This non-destructive testing (NDT) technique is widely used in various industries, including aerospace, automotive, medical, and power generation.
What does the FPI do? ›
The Football Power Index (FPI) is a measure of team strength that is meant to be the best predictor of a team's performance going forward for the rest of the season. FPI represents how many points above or below average a team is.
