Foreign Portfolio Investment vs Foreign Direct Investment which one is a better investment tool for a country? Every country needs funds to run their nation smoothly and this cannot be achieved by domestic funds alone. Foreign portfolio investment and Foreign Direct Investment are the two most important types of investment that are done by countries, especially by developing countries to raise funds.
These two terms are always in the limelight in the financial sector because once developing nations make investments it affects the economic growth of the country. But which investment is better when it comes to a comparison between foreign portfolio investment vs foreign direct investment?
Though both investments are foreign investments there are very few people who understand the true meaning of these two important foreign investments. Foreign investments basically mean when a country or institutions, corporations, and individuals of a country invest in some other country for better economic growth.
The investor country has two options for making foreign investments: Foreign portfolio investment and foreign direct investment. Let us understand these terms so that we can conclude which one is a better choice when it comes to foreign investment between foreign portfolio investment vs foreign direct investment.
Foreign Portfolio Investment (FPI)
Basically, foreign portfolio investment or FPI is a type of foreign investment that is made by various institutions, individuals, or even countries into the financial assets of another country. These financial assets may include stocks, bonds, and other financial products. In FPI, investors do not have much control over the investments made by them, you can assume that the FPI are generally made to generate potential financial returns.
Let us now look at some of the key characteristics and components of FPI that will help you to understand foreign portfolio investment more thoroughly.
Key Characteristics of FPI
Here are some key characteristics of FPI that you should know about, let us know about them and talk about them on a deeper level.
1. Financial Assets
As stated earlier in FPI, institutions from a country invest in the financial assets of other countries. These financial assets include various financial products such as bonds, stocks, mutual funds, and various other money market instruments of other countries in which they are investing.
In the financial world, it is said that the more financial products a country can offer, the more economic growth it can achieve from foreign investments. This is because the more financial products with good returns on investment a country can offer the more they attract foreign investors to invest in their country. These features help countries or individuals to make a better choice between foreign portfolio investment vs foreign direct investment.
2. Lack of Control
One of the major drawbacks of a foreign portfolio investment is that foreign investors do not have much authority over the investments made by them. We can also say that foreign investors do not have much authority in the management system of the financial assets or the operations of companies in which they make foreign portfolio investments.
By this, it is fair to conclude that foreign investors are not that much involved in the day-to-day practices followed by the invested companies. This is one of the major why foreign investors do not wish to invest using FPI as a preferred choice, because no matter where the investors are they like to have control and FPI lacks this feature. Since this drawback counts as a major drawback these help individuals to make a better choice between foreign portfolio investment vs foreign direct investment.
3. Short-Term Focus
The major aim of the countries or individuals while making foreign portfolio investments is profit making. So more often the investments made under FPI are generally focused on short-term investing. This is one of the major differences when it comes to making a choice between foreign portfolio investment vs foreign direct investment.
Investors look to make profits by the short-term fluctuations that are going on in the market. These fluctuations can occur in various financial products like asset prices, currency exchange rates, or interest rates.
The investors who invest through FPI have one strategy in mind they enter and exit in suitable positions quickly to earn more profit. Hence we can say that if investors have a short-term goal then they should with FPI in between foreign portfolio investment vs foreign direct investment.
One of the major reasons why investors choose FPI between foreign portfolio investment vs foreign direct investment is that they get a better chance to diversify their foreign funds geographically. The simple way to understand this is that investors can invest their money in different countries making their portfolio diversified.
The Investors who invest through FPI need diversification features because by using diversification they minimize the potential risk of one investment with another potential profit of another investment. So if you are an investor and are confused about what to choose between foreign portfolio investment vs foreign direct investment, keeping diversification as a primary objective you can go with foreign portfolio investment.
This is one of the major drawbacks which is faced by investors who want to invest in foreign countries because they have to face restrictions from both sides. By this, we mean that investors have to follow the rules for investing and receiving countries.
Having so many regulations makes FPI a tedious process, so sometimes investors choose FDI between foreign portfolio investment vs foreign direct investment when they have to make hassle-free investments.
The restrictions or regulations may include various limits on financial products such as limits on reporting requirements, tax implications, and ownership percentages. All these things make the process of investing tedious and reduce the profits.
Hence if you are an investor and are confused about what to choose between foreign portfolio investment vs foreign direct investment, keeping regulation as a primary objective you can go with foreign direct investment.
This is all that you need to understand about foreign portfolio investment so that you can understand the policies that are being made by the government of your country for better financial growth. Let us now discuss foreign direct investment, so that you can understand which one is better foreign portfolio investment vs foreign direct investment.
Foreign Direct Investment (FDI)
Foreign Direct Investment (FDI) is basically those investments that are made by certain individuals, governments, or businesses from one country into the physical assets of another country. These physical assets may include some companies, roads, banks, or any other physical assets that generate wealth.
As we have mentioned before, in Foreign Portfolio Investment (FPI) investors are required to make passive investments which means that they do not have much power when it comes to the management of the asset in which they have invested. But in FDI investors are required to make active investments which means that they have active participation in the decision-making of the assets in which they have invested.
So if you are an investor and want to have control over the investments that you make so that you can earn more and more profit then you should go with foreign direct investment as it will be a better choice for you between foreign portfolio investment vs foreign direct investment.
Let us now have a look at key some characteristics of foreign direct investment so that you can clearly understand the difference between foreign portfolio investment vs foreign direct investment and make a better financial choice.
Key Characteristics of FDI
Here are some key characteristics of FDI.
1. Ownership and Control
As we have said earlier, when an investor invests in foreign direct investment then he/she gets more authority in the physical asset in which he/she has invested. Till now it has been seen that investors who invest in FDI get a significant ownership stake which is usually 10% in a company in which they have invested from another country.
Having this much ownership stake in the company gives the investors a sense of influence and control over the company's management and operations. If want to have control over the investments that you make then you should go with foreign direct investment as it will be a better choice for you between foreign portfolio investment vs foreign direct investment.
2. Long-Term Perspective
As we have discussed in FPI it is a short-term investment, FDI is the complete opposite of it. Yup, you're right, FDI is made for long-term investment by foreign investors. This is because the investors who invest in FDI whether they are businessmen, individuals, or governments see the potential of making huge profits with the physical asset in which they are investing.
The investors who invest in FDI generally want to have a longer grip over the investments that they have made so they try to build a good relationship with the invested countries by forming branches, joint ventures, or by establishing subsidiaries. So if you're looking to make long-term foreign investments then you should go with FDI as it is a better choice for you between foreign portfolio investment vs foreign direct investment.
3. Transfer of Technology and Know-How
Transfer of technology is one of the biggest advantages that a host country could get in foreign direct investment. This is because the investors have significant ownership in the invested companies so they bring new technologies to the host country which helps to maximize the profit for themselves and this ultimately brings economic development in the host country.
If we look from the perspective of the host country then foreign direct investment turns out to be more better choice between foreign portfolio investment vs foreign direct investment, this is because foreign direct investment brings economic development in the country.
4. Job Creation
This is again one of the biggest advantages that a host country gets when individuals, businesses, and governments invest in their countries by using foreign direct investment, this is because these investments create great job opportunities in the host country. The funds that the host country gets can create many job opportunities.
Foreign direct investment has a great positive impact on local economies as well as employment rates. So if look from the eyes of the host country then we can say that foreign direct investment is a much better choice when a country has to choose from foreign portfolio investment vs foreign direct investment.
5. Risk and Reward
Foreign direct investment is known for having high risks but on the other hand, it has high rewards as well. There are various factors that influence the risks like economic risks, regulatory, as well as political risks. All these things affect the profit-making in the foreign country.
But as we said earlier Foreign direct investment has high rewards as well so if you're willing to take risks for better rewards then you should definitely go with foreign direct investment. But if you do not want to take risks and have the easy way out then you can invest in foreign portfolio investment. We suggest that you consult a financial advisor before making investments so that he can suggest which foreign investment will be better for you in between foreign portfolio investment vs. foreign direct investment.
Foreign Portfolio Investment vs Foreign Direct Investment
Let us quickly go through the difference between FPI and FDI, it will help you to make your decision easy and you will get more security about which investment is better than the other one. Here are the differences between FPI and FDI.
1. Level of Control
If we talk about FPI investor getting control in a foreign company, he purchases at least 10% shares of that particular company allowing him to say his side in the company and get some control over the company, whereas in FDI the investor does not have any control over the company's management, and the investment is subject to the performance of the financial markets.
2. Investment horizon
If we talk about the duration of each investment then FDI is a long-term investment and FPI is a short-term investment. FDI is a more strategic investment in comparison to FPI as it is a long-term investment so investors strategize every step in this.
3. Purpose of investment
FDI is frequently invested in to create a long-term corporate interest in a foreign nation. This includes creating a manufacturing site, buying a nearby business, or forming a partnership. FPI is frequently created to diversify investment portfolios, support the expansion of foreign economies, and seize transient market opportunities.
As FDI is a long-term investment it needs strategy and time so this type of investment holds higher risks than FPI. FPI, on the other hand, is vulnerable to the turbulence of the financial markets and is impacted by changes in interest rates, the value of the dollar, and other macroeconomic variables.
Frequently Asked Questions (FAQs)
There are many frequently asked questions asked by many people some of them are mentioned below.
Q1. What is a Foreign Portfolio Investment?
A1. Foreign Portfolio Investment refers to investments made by foreign individuals or institutions in financial assets like stocks, bonds, or other securities of a country.
Q2. What are the key characteristics of FDI?
A2. There are many key characteristics of FDI and some of them are mentioned here Ownership and Control, Long Term Perspective, Transfer of Technology and Know-How, Job Creation, and many more.
Q3. Is there any benefit of Foreign Portfolio Investment?
A3. Yes, there are many benefits that can be seen in Foreign Portfolio Investment some of them are Diversification, Liquidity, High Returns, Market Access, and many more.
Q4. Which investment has the risks?
A4. FDI is a long-term investment. It needs a good amount of time, hard work, and strategies as well, So, if we talk about which investment has the more risks it definitely is FDI as it is a long-term investment.
Happy to see you at the end of the article that means you read the whole article and I hope you found this article helpful this is a very common question to have in anyone's mind foreign portfolio investment vs foreign direct investment which one is actually better, and if you are also come in this category don't worry you are not very different as well.
I also had the same dilemma once and then found the results and then came up with this article we mentioned everything that you should know about this very particular topic. If you liked this article share this with your family and friends, especially with the ones who are thinking of investing their money but having second thoughts about where they should invest. If you have any query related to this article ask us in the comment section we will reach out to you as soon as possible. Stay connected for upcoming posts.