Foreign investment is defined as “the flow of capital from one country to another in exchange for significant ownership stakes in domestic companies or other domestic assets” (Investopedia 2015). Simply put foreign investment is putting up capital for a business opportunity in a country other than the home country. In the wake of the recent economic crisis that originated in the collapse of the US housing bubble in 2007, investing in international market is a smart business move to ultimately reduce the risk entailed in business ventures.
The most attractive aspect of foreign investment is that it provides greater opportunity for portfolio diversification. The rule is that the risk of an entire portfolio may be less than that of its individual components. Portfolio is defined as a “collection of investments assembled to meet one or more investment goals” (Gitman 2008, p. 134). Diversification is a strategy used to reduce risk, which in everyday parlance is akin to avoiding placing all of one’s eggs in the same basket so that when one egg goes bad, the other eggs placed in other baskets are not affected. In this strategy, investment is spread on a variety of assets chosen on their expected returns. In addition, the correlation between the individual returns is also considered with the end goal of reducing risk for a given level of anticipated return (Clark 2002, p. 293). The rule is that the lower the correlation between two assets, the lower is the risk expected when the two are mixed in an investment portfolio (Gitman et al 2008, p.137).
Investing in the international market maximizes portfolio diversification. This is because of the wider and broader range of assets and investments available in an international market. This is true particularly for investors coming from countries with limited diversification opportunities. Studies have proved that portfolio diversification in the international market offers more reduction in risks than portfolio diversification in a domestic market alone. A study made between 1978 and 1992 covering 12 European countries involving 7 different industries proved this. The study discovered that risk is reduced more when diversifying in the same industry in several countries than when diversifying in different industries in the same domestic market. If diversification is made in several industries in various countries, the risk reduction is even greater (Gitman et al 2008, p. 142).
It can be said, thus, that the primary benefits that international investment offers to the investor is better diversification opportunity and enhanced returns or growth. Aside from more variety of choices, international investment gives an investor access to the top corporations in the world in all sectors that are performing at the top of their respective industries. The top-performing country changes almost every year and by wisely diversifying globally, an investor can consistently includes the best performing market in its portfolio. For example, Spain was the best-performing market in 1996, but the following year the spot was taken by Switzerland. For two consecutive years in 1998 and 1999, Finland took home that honor, but was soon regained by Switzerland in 2000. New Zealand, Greece, Australia and Canada were also able to take the spot in subsequent years (AIM Trimark 2006, p. 10). Exposure to these top-performing markets and emerging markets is an opportunity for business growth, which means increased returns.
While there are benefits to investing in international market, it also carries several risks. Some of these known risks are currency-related, settlement risk, liquidity risk and transfer or political risk. Currency risk refers to the risk that occurs when domestic currency appreciates vis-à-vis the currency in which the investment is held. When this scenario happens, the result is a reduced return when it is converted to domestic currency. Settlement risk, on the other hand, refers to the risk that occurs when there is a failure of delivery of payment after a transaction involving the investment. This kind of risk is possible with investments in less-developed countries. Liquidity risk arises when an investor is unable to divest itself of the investment because of difficulties in liquidating due to the narrowness of the market of such investment. Finally, transfer or political risk occurs when the government where the investment is held imposes a regulatory measure that the investor failed to anticipate and as a result, the investor is locked to that position. With the exclusion of the currency rate, these risks can be prevented or minimized by carefully and wisely selecting the countries to invest particularly avoiding notoriously unstable countries (Blake p. 469).
There are various ways of investing in international market. Some of these methods are conducted investments through mutual funds, exchange-traded funds, American depositary-receipts, US-traded foreign stocks, and stocks trading on foreign markets. Mutual funds are pooled funds of various investors to be invested in business companies. The types of mutual funds include global funds, international funds, regional or country funds, and international index funds. Exchange-traded funds or EFTS, on the other hand, are companies that invest to get the same return as a particular market index and are listed on stock exchanges. American Depositary Receipts or ADR are foreign companies stocks traded in the US, while US-traded foreign stocks are also foreign stocks traded in the same manner as local stocks. Finally, stocks trading on foreign markets are investments stocks that trade only in the foreign market that may be processed by a broker (SEC 2012).
The impact of the 2007 economic crisis has stunned many in the business world. Investing in international market may provide an opportunity for investors to secure their investments through portfolio diversification, which ensures the reduction of risk of their entire portfolio. Moreover, international investment offers opportunity and access to be part of growing and emerging markets as well as top-performing markets.
Reference
AIM Trimark (2006). Discovering Benefits beyond our Borders: The Benefits of Global Investing. Retrieved from https://www.invesco.ca/publicPortal/ShowDoc?nodePath=/BEA%20Repository/common/library/PDF/global_opportunities/BRGLOB//eBinary
Blake, D. (2003). Pension Schemes and Pension Funds in the United Kingdom. Oxford University Press.
Clark, E. (2002). International Finance. Cengage Learning EMEA.
Gitman, L. and M. Joehnk, S. Smart, R. Juchau, D. Ross, S. Wright. (2008). Fundamentals of Investing. Pearson Higher Education.
Investopedia (2015). Foreign Investment. Retrieved from http://www.investopedia.com/terms/f/foreign-investment.asp.
SEC (2012). International Investing. United States Securities and Exchange Commission. Retrieved from http://www.sec.gov/investor/pubs/ininvest.htm.
