International Portfolio Management

International Portfolio Management, also known as International Portfolio Management or Foreign Portfolio Management, refers to grouping of investment assets from international or foreign markets rather than from the domestic ones. The asset grouping in GPM mainly focuses on securities. The most common examples of International Portfolio Management are:

• Share purchase of a foreign company
• Buying bonds that are issued by a foreign government
• Acquiring assets in a foreign firm

Factors Affecting International Portfolio Investment

International Portfolio Management (GPM) requires an acute understanding of the market in which investment is to be made. The major financial factors of the foreign country are the factors affecting GPM. The following are the most important factors that influence GPM decisions.

1. Tax Rates

Tax rates on dividends and interest earned is a major influencer of GPM. Investors usually choose to invest in a country where the applied taxes on the interest earned or dividend acquired is low. Investors normally calculate the potential after-tax earnings they will secure from an investment made in foreign securities.

2. Interest Rates

High interest rates are always a big attraction for investors. Money usually flows to countries that have high interest rates. However, the local currencies must not weaken for long-term as well.

3. Exchange Rates

When investors invest in securities in an international country, their return is mostly affected by −

• The apparent change in the value of the security.
• The fluctuations in the value of currency in which security is managed.

Investors usually shift their investment when the value of currency in a nation they invest weakens more than anticipated.

Modes of International Portfolio Management

Foreign securities or depository receipts can be bought directly from a particular country’s stock exchange. Two concepts are important here which can be categorized as Portfolio Equity and Portfolio Bonds. These are supposed to be the best modes of GPM. A brief explanation is provided hereunder.

1. Portfolio Equity

Portfolio equity includes net inflows from equity securities other than those recorded as direct investment and including shares, stocks, depository receipts (American or international), and direct purchases of shares in local stock markets by foreign investors.

2. Portfolio Bonds

Bonds are normally medium to long-term investments. Investment in Portfolio Bond might be appropriate for you if:

• You have additional funds to invest.
• You seek income, growth potential, or a combination of the two.
• You don’t mind locking your investment for five years, ideally longer.
• You are ready to take some risk with your money.
• You are a taxpayer of basic, higher, or additional-rate category.

3. International Mutual Funds

International mutual funds can be a preferred mode if the Investor wants to buy the shares of an internationally diversified mutual fund. In fact, it is helpful if there are open-ended mutual funds available for investment.

4. Closed-end Country Funds

Closed-end funds invest in internationals securities against the portfolio. This is helpful because the interest rates may be higher, making it more profitable to earn money in that particular country. It is an indirect way of investing in a international economy. However, in such investments, the investor does not have ample scope for reaping the benefits of diversification, because the systematic risks are not reducible to that extent.

Drawbacks of International Portfolio Management

International Portfolio Management has its share of drawbacks too. The most important ones are listed below.

1. Unfavorable Exchange Rate Movement

Investors are unable to ignore the probability of exchange rate changes in a foreign country. This is beyond the control of the investors. These changes greatly influence the total value of foreign portfolio and the earnings from the investment. The weakening of currency reduces the value of securities as well.

2. Frictions in International Financial Market

There may be various kinds of market frictions in a foreign economy. These frictions may result from Governmental control, changing tax laws, and explicit or implicit transaction costs. The fact is governments actively seek to administer international financial flows. To do this, they use different forms of control mechanisms such as taxes on international flows of FDI and applied restrictions on the outflow of funds.

3. Manipulation of Security Prices

Government and powerful brokers can influence the security prices. Governments can heavily influence the prices by modifying their monetary and fiscal policies. Moreover, public sector institutions and banks swallow a big share of securities traded on stock exchanges.

4. Unequal Access to Information

Wide cross-cultural differences may be a barrier to GPM. It is difficult to disseminate and acquire the information by the international investors beforehand. If information is tough to obtain, it is difficult to act rationally and in a prudent manner.

Benefits of Portfolio capital flows

Foreign portfolio investment is a type of investment that an investor has abroad. A foreign portfolio investment can include a variety of different assets held in foreign countries, including bonds, stocks, and cash equivalents. They can be managed by finance professionals or directly held by an investor.

Most foreign portfolio investments are passively held by the investor. Though their liquidity does depend on the volatility of the foreign market in which they are held, foreign portfolio investments can be very liquid.

There are many benefits to having a foreign portfolio investment. It offers investors a way to diversify their holdings, and benefit from international investment diversification.

Benefits and costs of portfolio capital flows have been a subject of severe controversy. Private foreign portfolio investment in stocks, equities and bonds has been made by foreign investors in order to get higher return or higher interest on their investment and also to diversify their portfolio in order to reduce risk. Thus, Prof. Todaro rightly writes, “From the investor’s point of view, investing in the stock markets of emerging countries permits them to increase their returns while diversifying their risks.”

In the early 1990s the return on the portfolio investment in the so called ’emerging’ developing countries was quite high, for instance it was 39 per cent during 1988-93 in Latin America which is main recipient of portfolio capital flows. But the high returns were marred by high volatility of stock markets of these countries.

Benefit from Exchange Rate

International currency exchange rates keep changing. Sometimes the currency of the investor’s home country may be strong, and sometimes it may be weak. There are times when a stronger currency in the foreign country where an investor has a portfolio may benefit the investor.

Access to a Bigger Market

Home markets in the United States have become very competitive, as there are many businesses offering similar services. Foreign markets, however, offer a less competitive and sometimes larger market.

Liquidity

Where foreign portfolio investments are very liquid, they can be bought and sold quickly and easily. Higher liquidity means greater buying power for investors, as it gives them access to a ready stream of cash. That means that investors holding foreign portfolio investments are better-positioned to act quickly when good purchase opportunities arise.