Foreign Portfolio vs. Foreign Direct Investment: An Overview

Foreign investment, quite simply, is investing in a country other than your home one. It involves capital flowing from one country to another and foreigners having an ownership interest or a say in the business. Foreign investment is generally seen as a catalyst for economic growth and can be undertaken by institutions, corporations, and individuals.

Investors interested in foreign investment generally take one of two paths: foreign portfolio investment or foreign direct investment. 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).

Foreign direct investment (FDI) refers to investments made by an individual or firm in one country in a business located in another country. Investors can make foreign direct investments in a number of ways. Some common ones include establishing a subsidiary in another country, acquiring or merging with an existing foreign company, or starting a joint venture partnership with a foreign company.

Key Takeaways

  • Foreign portfolio investment is the purchase of securities of foreign countries, such as stocks and bonds, on an exchange.
  • Foreign direct investment is building or purchasing businesses and their associated infrastructure in a foreign country.
  • Direct investment is seen as a long-term investment in the country's economy, while portfolio investment can be viewed as a short-term move to make money.
  • Direct investment is likely only suitable for large corporations, institutions, and private equity investors.

Foreign Portfolio Investment (FPI)

Foreign portfolio investment (FPI) refers to investing in the financial assets of a foreign country, such as stocks or bonds available on an exchange. This type of investment is at times viewed less favorably than direct investment because portfolio investments can be sold off quickly and are at times seen as short-term attempts to make money, rather than a long-term investment in the economy.

Portfolio investments typically have a shorter time frame for investment return than direct investments. As with any equity investment, foreign portfolio investors usually expect to quickly realize a profit on their investments.

As securities are easily traded, the liquidity of portfolio investments makes them much easier to sell than direct investments. Portfolio investments are more accessible for the average investor than direct investments because they require much less investment capital and research.

Unlike direct investment, portfolio investment does not offer the investor control over the business entity in which the investment is made.

Foreign Direct Investment (FDI)

Foreign direct investment (FDI) involves establishing a direct business interest in a foreign country, such as buying or establishing a manufacturing business, building warehouses, or buying buildings.

Foreign direct investment tends to involve establishing more of a substantial, long-term interest in the economy of a foreign country. Due to the significantly higher level of investment required, foreign direct investment is usually undertaken by multinational companies, large institutions, or venture capital firms. Foreign direct investment tends to be viewed more favorably since they are considered long-term investments, as well as investments in the well-being of the country itself.

At the same time, the nature of direct investment, such as creating or acquiring a manufacturing facility, makes it much more difficult to liquidate or pull out of the investment. For this reason, direct investment is usually undertaken with essentially the same attitude as establishing a business in one's own country—with the intention of making the business profitable and continuing its operation indefinitely. For the investor, direct investment means having control over the business invested in and being able to manage it directly. It also involves more risk, work, and commitment compared to foreign portfolio investment.

Special Considerations

When making foreign investments, investors have to consider economic factors as well as other risk factors, such as political instability and currency exchange risk. One of the riskier forms of foreign direct investment is called green-field investing. Multinational corporations will use green-field investing to create a new subsidiary in a foreign country, frequently in an emerging market. The term green-field is used because the parent company builds the subsidiary from the ground up (similar to a farmer preparing a field for planting).

A downside to green-field investing is the enormous amount of money the parent company may need to spend to get the subsidiary operating. This may include the purchase of land, the building of production facilities, and the training of a local labor force. Other barriers to entry may include meeting local restrictions on foreign businesses, paying required taxes and permit fees, and requirements for the use of domestically manufactured components.