In recent years international business activity has been characterized by a dramatic increase in cross-border financial activity. International flows of financial securities have outstripped gains from goods and services trade and, consequently, investment opportunities were no longer constrained by domestic markets. These significant changes gave impetus to the popularity of direct or portfolio investments in foreign countries.
Foreign portfolio investment (FPI) is short- or long-term investing activity in corporate stocks and bonds, mutual and hedge funds, government bonds, pension and sovereign funds, various financial derivatives, certificates of deposit, real estate investment trusts, etc. Foreign portfolio investment is relatively liquid, mostly depending on the riskiness of the market where securities and other financial assets are held in. Moreover, FPI is the best choice for investors who are not willing to manage direct ownership rights of a foreign company.
The benefits of diversification are well perceived by portfolio managers, that many in developed countries started investing in foreign bonds, stocks and other instruments. They found that can extend diversification principle to foreign stocks, bonds etc, to improve returns for a given risk by adopting proper techniques of diversification.
Need of International Diversification:
- The size and character of international Equity and bond markets are widely varying that it will increase the scope for larger investment and larger diversification.
- The returns in local currencies of some foreign countries are higher than in domestic markets. Thus, for example in Singapore, Malaysia, Taiwan and India the returns in local currencies are higher than in U S economy.
- The economic trends, business conditions and local profitability and earnings ratio differ widely among countries that the EPS in some developing countries is higher and give opportunity for better diversification and higher returns, through international investments.
- International investment is advantageous due to larger investment avenues now open in the first place and secondly due to the imperfect correlation among the international investment markets. The total risk of a portfolio including the international investment will be lower than with only domestic investment. The degree of volatility, and all risk measures, indicates that these risks vary among the countries and in different degrees and the possibility of covariance, or high correlation will be low.
The frontier of efficiency portfolio can be widened, by inclusion of foreign investment in a portfolio. Thus many international portfolio managers prefer to invest in India and so will be the case of India n portfolio managers, if they can diversify into international investment. There are some directions however, which will increase risk in such investment.