Simplifying FDI/FII in Emerging markets – What’s your best bet?

Since the mid-1990s, we’ve been seen a prominent trend in investment portfolios around the world: the increasing importance of emerging markets. While the USA still dominates global FDI stock, accounting for 25% of FDI, this number is only set to shrink.[1] In fact, emerging markets have already whittled this amount down from the 37% market dominance it used to have as recently as 2020![2]

Especially since 2014, when EMs accounted for more than half of all global FDI flows for the first time, these economise have become excellent choices for both long-term and short-term investments.[3]

For those considering a long-term plan on returns, foregoing short-term goals and being prepared to incur a few losses is essential.[4] Top-performing companies that have managed to increase revenues through FDI stress the importance of long-term reputational maintenance and trust-building over instant profits.[5] Those who manage to strategize appropriately can look forward to favourable earnings on a 5-year forward basis.[6] According to Bloomberg, MSCI Emerging Markets IMI estimates are around 17.8% at an annualized rate when compared to the American S&P 500 Index, which gives an annualized rate of 11.9%.[7]

It’s also worth noting that FDI can have a cumulative and transformative impact on markets, leading to better regulations, governance standards, and a closer alignment with international policies.[8] This increased international participation can work as a feedback loop that ultimately increases firms’ efficiency, reduces cost of capital, and facilitates liberalisation and integration which in turn fosters further FDI.[9]

However, emerging markets can also be notoriously volatile – the year on year earnings per share growth for the MSCI Emerging Markets Index between 2011 and 2017 was practically zero due to extreme fluctuations![10] This volatility is hard to weather for many and is also, frankly speaking, undesirable to most. If you’re looking for short-term returns, then turning to FII instead of FDI is the more practical way to go.

FIIs can react quickly not only to local volatility-inducing factors but also to global developments and thus stand to make the most of equities in emerging markets such as India and Brazil, whose Sensex and Bovespa Index respectively tend to trade higher than the S&P.[11] If you can keep a good eye on the horizon, and on your news screens, then you’ll be primed to reap profits while avoiding negative volatility. A prime example of the mobility offered by FIIs has been in the recent coronavirus crisis, with the record outflows registered in India in March surpassing even the 2008 crisis.[12] At the same time, many investors are looking to easily re-enter the market once the economy starts back up again and when the threat of the virus fizzles out.[13][14]

The recent crisis and the uncertainty it has precipitated actually helps foreground a crucial fact about investing in EMs: it’s all contextual. EMs such as India which were earlier safe-havens during the 2008 crisis are now facing significant issues with NBFCs and an economic reform plan that has decided to foreground national self-sufficiency over global integration.[15][16] Not just local factors, but even global changes are important to consider – especially the fact that we’ve been seeing a global fall in FDI for four years straight.[17] Keeping context in mind is thus key to making the most of emerging markets since the individual strengths of each will need to be assessed.

Despite these differences and changes in emerging markets in the face of recent events, it is always reassuring to remember that crises actually tend to the shore up the importance of EMs. With the global economic fallout from the US-China trade war, Vietnam, for instance, has emerged as a significant winner in terms of new FDI flows while in the 2008 fiscal crisis, it was India that remained a safe bet.[18][19]

FDI and FII in these markets are, therefore, better analysed according to your own needs and capabilities. The markets that are classified as EMs are, at the end of the day, quite heterogeneous and choosing between them will require trade-offs between risks and earning potentials of the assets you choose to invest in.[20] But whether you’re in it for the long-haul or to just dip your toe in the water, EMs definitely should be on your investment radar if they’re not in your portfolio already.

[1] https://www.forbes.com/sites/danikenson/2018/10/17/the-economic-bedrock-of-foreign-direct-investment/#37bfa47b71a4

[2] https://www.forbes.com/sites/danikenson/2018/10/17/the-economic-bedrock-of-foreign-direct-investment/#37bfa47b71a4

[3] https://unctad.org/en/PublicationsLibrary/webdiaeia2015d1_en.pdf

[4] https://hbr.org/2015/09/what-companies-have-learned-from-losing-billions-in-emerging-markets

[5] https://hbr.org/2015/09/what-companies-have-learned-from-losing-billions-in-emerging-markets

[6] https://www.forbes.com/sites/advisor/2018/08/01/should-long-term-investors-own-more-emerging-market-equities/#7b1ffe5554ee

[7] https://www.forbes.com/sites/advisor/2018/08/01/should-long-term-investors-own-more-emerging-market-equities/#7b1ffe5554ee

[8] https://www.world-exchanges.org/storage/app/media/research/Studies_Reports/2018/WFE%20attracing%20int%20investors%20report%20FINAL%20VERSION%20updated%205.12.18.pdf

[9] https://www.world-exchanges.org/storage/app/media/research/Studies_Reports/2018/WFE%20attracing%20int%20investors%20report%20FINAL%20VERSION%20updated%205.12.18.pdf

[10] https://www.forbes.com/sites/advisor/2018/08/01/should-long-term-investors-own-more-emerging-market-equities/#7b1ffe5554ee

[11] https://www.forbes.com/sites/kenrapoza/2018/12/12/outlook-2019-emerging-markets-are-better-than-the-u-s-if-dollar-cooperates/#63e7df64157f

[12] https://www.livemint.com/market/stock-market-news/march-sees-highest-ever-sell-off-by-fiis-11585509009597.html

[13] https://economictimes.indiatimes.com/markets/expert-view/fii-flows-will-return-to-ems-once-virus-problem-is-over-mark-mobius/articleshow/74441106.cms?from=mdr

[14] https://economictimes.indiatimes.com/markets/stocks/news/when-will-fiis-return-to-d-street-go-ask-nbfcs-and-north-block/articleshow/75619422.cms

[15] https://economictimes.indiatimes.com/markets/stocks/news/when-will-fiis-return-to-d-street-go-ask-nbfcs-and-north-block/articleshow/75619422.cms

[16] https://economictimes.indiatimes.com/news/economy/policy/summing-up-modis-covid-stimulus-takeaways-so-far-from-the-mother-of-all-incentives/articleshow/75758840.cms

[17] https://www.wsj.com/articles/foreign-investment-falls-to-near-decade-low-as-globalization-slows-11579525200

[18] https://www.forbes.com/sites/riskmap/2018/12/14/vietnam-fdi-explosion-and-trade-wars/#59fe70617e99

[19] https://economictimes.indiatimes.com/markets/stocks/news/when-will-fiis-return-to-d-street-go-ask-nbfcs-and-north-block/articleshow/75619422.cms

[20] https://www.sciencedirect.com/science/article/abs/pii/S0969593113001327