International Portfolio Investment

Submitted by: Arun Sharma 12-MBA-10

International Portfolio Investment

FPI (Foreign Portfolio Investment) represents passive holdings of securities such as foreign stocks, bonds, or other financial assets, none of which entails active management or control of the securities' issuer by the investor.

Why Go Global?
In a nutshell: Diversification!!!
Potential for higher expected returns for same risk. Potential for lower portfolio risk for same return.
Expected return International investing Domestic investing

Standard deviation of return

International Diversification
Security returns are much less correlated across countries than within a country.
This is because economic, political, institutional and even psychological factors affecting security returns tend to vary across countries, resulting in low correlations among international securities.
Types of companies in each country can also vary significantly.

Domestic vs. International Diversification

100 Portfolio Risk (%)

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12 1 10

Indian stocks International stocks 20 30 40 Number of Stocks 50

International Investing
There are many important cross-country differences that matter when we invest internationally Country Risk Currency Risk

Limitations of Domestic Investment

If we only invest in domestic shares, then we are limited by the types of companies on offer in our home market. For example, the Australian market is overweight in mining companies and underweight in technology companies compared to the US and other markets. If we want to invest in IT or electronics companies, how do we do that in Australia? By investing internationally, we have a more diverse range of investment opportunities.

Exchange Rate Risk

The realized rupee return for an Indian resident investing in a foreign market will depend not only on the return in the foreign market but also on the change in the exchange rate between the Indian rupee and the foreign currency, i.e.
Uncertainty about what will happen to the foreign stock market (rforeign market). Uncertainty about what will happen to the exchange rate

How to Invest?
Direct share investment purchase shares in foreign markets using foreign currencies. Can be hard to do!

ADRs/GDRs purchase shares in foreign companies that are traded on your home exchange in local currency. Limited number! MNCs why cant we just buy shares in multinational companies to diversify internationally? Diversification benefits not as good as investing internationally!
So what are the easy ways?
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International Mutual Funds

An Indian investor can easily achieve international diversification by investing in an Indian-based international mutual fund. The advantages include:
1. Savings on transaction and information costs. 2. Circumvention of legal and institutional barriers to direct portfolio investments abroad. 3. Professional management and record keeping.

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Country Funds
Recently, country funds have emerged as one of the most popular means of international investment. A country fund invests exclusively in the stocks of a single country. This allows investors to: 1. Speculate in a single foreign market with minimum cost. 2. Construct their own personal international portfolios. 3. Diversify into emerging markets that might be inaccessible to individual investors.

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Other Avenues
Exchange Traded Funds ETFs are investment companies,
registered with the SEC with assets consisting of baskets of securities included in an index fund.
One share in an ETF provides an investor diversification to all the constituents of the relevant index and its price and yield track the indices performance.

World Equity Benchmark Shares (WEBS)/iShares Country specific baskets of stocks designed to replicate indices of 14 countries.
Low cost, convenient way for investors to hold diversified investments in several different countries.

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FDI AND FPI

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Purposes
The purposes of FDI and portfolio investments are different. FDI allows investors to be actively involved in their investment. Investors not only can take strategic decisions like what their foreign subsidiary will produce, in what quantities and for whom, but also are involved in operational issues like cost control, HR, and regulatory compliance. Investors may be motivated by different reasons including improving operations of their existing businesses, and closely monitoring and safeguarding their investments. Investors who decide to put their money in portfolios, are pursuing different objectives. They want to spread the risk, without the need to learn about how to run different 14 businesses.

Investors
Individuals and companies making FDI and portfolio investments are usually very different investors. FDI investors are often big multinational companies, social organization (NGOs), governmental or quasi governmental organizations (e.g., USAID) and venture capitalists. They either get into partnerships with local enterprises, set up affiliates, or make acquisitions of a foreign companies. Portfolio investors are mutual funds, hedge funds, pension funds, and other investors who wish to diversify their investments and not get involved in the day-to-day running of the companies they buy into.
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Risks
The risks associated with FDI and portolio investment primarily are country risk and currency exchange risk. The country risk includes political and economic instability (revolutions, nationalization, tax hikes), and corruption. The currency exchange risk occurs when the exchange rate of the country that has been invested in moves sharply against the exchange rate of the home country. It is necessary to note that even if investments (both FDI or portfolio investments) are denominated in the home country currency (e.g., U.S. dollars), investors still bear the exchange rate risk to some degree because the cash flows their investments generate will need to be converted into the home currency and if the exchange rate has moved substantially, the returns will suffer.
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Returns
Returns on FDI and portfolio investment are in line with average returns in the country they are invested into. However, portfolio investments are more liquid, which normally leads to higher valuations. But, on the other hand, FDI does not suffer from being a minority investment, which should give it the so-called control premium. On balance, though, FDI and portfolio investment have similar returns.

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Macroeconomic Impact
Portfolio investment is much more volatile than FDI. In periods of crisis, foreign portfolio investments are the first to leave the country, putting downward pressure on the domestic exchange rate, often causing depreciation of the currency of the country from which they are withdrawn. The underlying reason is that the market for portfolio investment is much more liquid, making it easier to take it out of a country (unless the country in question introduces capital controls, which is not good for its reputation). Because of this, FDI is a preferred source of capital, especially for developing countries.
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THANK YOU
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