Direct investment vs Portfolio investment

Direct investment vs Portfolio investment

Businesses that venture abroad are presented with a range of investment opportunities, two of which are foreign direct investment (FDI) and foreign portfolio investment (FPI). While FDI may be unfamiliar to many, some of you have probably heard about FPIs from numerous financial tabloids.

Although the two terms may initially seem similar, there are notable distinctions between foreign investment and trade. Therefore, FPI vs. FDI has different implications and significance due to their different approaches to international investment.

What is Foreign Direct Investment (FDI)?

A foreign entity investing in another country to establish a long-term commercial presence is known as foreign direct investment or FDI. Purchasing at least 10% of a foreign company’s shares to obtain a controlling interest and give the investor management power is known as foreign direct investment or FDI. 

MNCs, big institutions, or venture capital firms typically undertake FDIs because of the much higher investment level needed. Furthermore, because FDI is viewed as a long-term investment in the prosperity of the receiving nation, it is also regarded as more advantageous.

Latest FDI Trends In India

The country has received $953.143 billion in foreign direct investment (FDI) over the course of the last 23 years (April 2000 to September 2023) while $615.73 billion, or nearly 65% of the total FDI inflow over the previous 9 years (April 2014 to September 2023) has been received. $70.97 billion in total FDI inflows and $46.03 billion in total FDI equity inflows were made into the nation in FY 22–23.

What is Foreign Portfolio Investments (FPI)?

The word FPI, or foreign portfolio investment, describes foreign portfolio investors who make international investments in stocks, bonds, and other financial assets. Foreign Power Investment (FPI) does not involve taking over the company, in contrast to FDI. It’s a short-term trading strategy that involves buying and selling securities and is influenced by market trends.

Because portfolio investments can be quickly sold off and are sometimes perceived as short-term attempts to make money rather than long-term economic investments, this type of investment is therefore viewed less favorably than direct investment.

Foreign Principal Investors (FPIs) in India comprise investment groups of Qualified Foreign Investors (QFIs), Foreign Institutional Investors (FIIs), subaccounts, etc. FPI does not apply to NRIs.

Latest FPI Trends in India

Foreign portfolio investors (FPIs) made a comeback as buyers in 2023, purchasing Indian equities valued at ₹1.65 lakh crore, following outflows of ₹1.21 lakh crore in 2022. The FPI inflow reached its highest point since 2020 when purchases totaled ₹1.7 lakh crore.

Difference Between Foreign Portfolio Investment  vs Foreign Direct Investment

Here’s a comparison table highlighting the Difference Between FPI vs FDI:

Aspect	Foreign Portfolio Investment (FPI)	Foreign Direct Investment (FDI)
Definition	Investment in securities (stocks, bonds, etc.) of foreign companies or governments	Investment in physical assets, companies, or businesses  abroad
Type of Investment	Indirect Investment	Direct Investment
Control	Limited control or influence over the invested company	Significant control and influence over the invested company
Investment Purpose	Mostly focused on short-term returns with liquidity	Committed for long-term growth and development
Level of Control	Very low or no control	High control
Entry & Exit	Relatively easy	Difficult
Capital Movement	Quick and easier movement of capital across borders	Capital movement often subject to tighter regulations
Impact on Economy	This can lead to volatility in capital markets	Direct contribution to economic growth and job creation
Information	Reliance on market information for investment decisions	In-depth knowledge of the invested company and industry
Risk	Volatility	Stable
Examples	Investing in foreign stocks, bonds, mutual funds, ETFs, etc.	Acquiring a company, setting up production facilities, etc.

How to Choose Between FPI vs FDI?

When deciding between FPI and FDI, keep the following important factors in mind:

• Ownership and Control: Determine how much ownership and control you want. Whereas FPI offers no significant control or ownership, FDI gives the invested company much ownership and control.
• Investment Horizon: Consider how long you want to invest. FPI is usually short- to medium-term, but FDI requires a long-term commitment.
• Volatility and Risk: Take your risk tolerance into account. FPI is more vulnerable to short-term capital flows and market swings, while FDI is more stable because of its long-term nature.
• Sector and Point of Interest: Choose your investment’s sector and focus. While FPI focuses on financial markets, including stocks, bonds, and mutual funds, FDI concentrates on business operations, physical assets, and infrastructure.

What are the Pros and Cons of FDI vs FPI?

Pros of Foreign Direct Investment (FDI):

• Economic Growth: FDI can contribute to economic growth by creating jobs, improving infrastructure, and introducing new technologies and management practices.
• Transfer of Skills and Knowledge: FDI brings with it technical expertise, knowledge, and best practices that can benefit the local workforce and industries.
• Long-Term Commitment: FDI is typically long-term, which provides stability and confidence to the host country, attracting further investment and stimulating economic development.

Cons of Foreign Direct Investment (FDI):

• Loss of Sovereignty: Hosting a significant amount of FDI can potentially lead to losing control over key industries or sectors, as decision-making authority may shift to foreign investors.
• Dependence on Foreign Capital: Reliance on FDI can create a situation where the host country becomes heavily dependent on foreign capital, making it vulnerable to external shocks and fluctuations in global financial conditions.
• Adverse Impact on Small Businesses: FDI can sometimes create an uneven playing field, as large multinational corporations may have a competitive advantage over smaller local businesses, potentially leading to market concentration and reduced competition.

Pros of Foreign Portfolio Investment (FPI):

• Liquidity and Diversification: FPI allows investors to diversify by investing in various assets and markets, offering liquidity and easier exit strategies.
• Market Efficiency: FPI contributes to the efficiency of financial markets by providing capital to companies, helping price discovery, and facilitating the transfer of risk.
• Potential for Higher Returns: FPI can offer the opportunity for higher short-term returns, particularly in cases where investors have expertise in identifying undervalued securities.

Cons of Foreign Portfolio Investment (FPI):

• Volatility and Speculation: FPI can introduce volatility to financial markets, as flows of capital in and out of securities can be influenced by market sentiment, leading to excessive speculation and short-term investor behavior.
• Lack of Long-Term Commitment: FPI typically lacks a long-term commitment to the invested company or the host country’s development goals, making it more susceptible to sudden capital outflows during times of economic instability.
• Limited Control and Influence: FPI investors generally have limited control or influence over the companies they invest in, making it challenging to directly impact strategic decisions and operations.

Bottom Line

In general, it’s important to distinguish between foreign investment and trade. While FDI has definite advantages like job creation and technology transfer, it also comes with higher risks and demands more dedication. Although FPI offers flexibility and diversification, it is less controllable over the underlying companies and is more volatile. 

The state of the market, individual investment goals, and risk tolerance influence the decision between FDI and FPI. To make an informed choice, speaking with experts or financial advisors is advisable.

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FAQs

Q1.  What is the difference between FDI and FPI?

A. The main difference between FDI and FPI is the level of control and risk involved. In FDI, investors have a direct stake in managing and controlling foreign businesses, which can be a riskier investment. In contrast, FPI involves passive investments like buying stocks and bonds, which carry less risk.

Q2. Who regulates FDI and FPI in India?

A. In India, the regulation of Foreign Direct Investment (FDI) and Foreign Portfolio Investment (FPI) is overseen by SEBI. SEBI serves as the regulatory authority for the FPI regime, consolidating the previous modes of Foreign Institutional Investors (FII) and Qualified Foreign Investors (QFI) to streamline foreign investment into the country.

Q3. Is FPI less risky than FDI?

A. When comparing Foreign Portfolio Investment (FPI) to Foreign Direct Investment (FDI), FPI carries less risk. This is because FPI investors do not have direct control over the securities or businesses they invest in. As a result, FPI tends to offer higher liquidity and lower risk when compared to FDI.

Q4. How do FDI and FPI affect the economy?

A. FDI can bring important benefits to host countries, such as increased job opportunities, money inflow, transfer of technology, and managerial skills. FPI, on the other hand, can increase capital inflows, market efficiency, and liquidity, but may also create volatility and increase external vulnerability to sudden outflows.

Q5. Which is a better investment, FDI or FPI?

A. There is no one-size-fits-all answer to this question, as the better investment depends on an investor’s financial goals, risk appetite, and investment horizon. FPI is generally considered a less risky investment strategy as compared to FDI, but FDI offers the opportunity for long-term gains and greater control over investments.