With the continuous development of economic globalization, direct investment and portfolio investment have become important forms of international capital flow. Understanding their differences can help investors make better investment decisions. This article will focus on the key differences between direct investment and portfolio investment from the perspective of purpose, control, risk, liquidity and other dimensions.
The purpose of direct investment is long-term control while portfolio investment aims at financial gain
The most essential difference between direct investment and portfolio investment lies in their respective purposes. Direct investment refers to the behavior of investors directly investing capital abroad to establish enterprises or jointly operate enterprises with local partners, with the purpose of obtaining long-term control and management rights. While portfolio investment means purchasing foreign securities through international financial markets, with the sole purpose of making financial gains rather than controlling the investment targets. In short, direct investment focuses on control while portfolio investment chases quick profits.
Direct investors obtain actual control while portfolio investors get no control
As mentioned above, the core purpose of direct investment is to obtain the actual control of overseas enterprises, including participation in decision-making and daily management of the invested enterprises. However, portfolio investors only passively hold the shares or bonds of foreign companies or governments, without any control over the investment targets. Their relationship is simply between investors and investees. Therefore, direct investment can help investors deeply participate in local economic activities and influence corporate strategies, while portfolio investment does not grant such capabilities.
Direct investment undertakes higher risk than portfolio investment
Judging from the perspective of investment risk, direct investment is generally riskier than portfolio investment. On the one hand, direct investment usually adopts a long-term buy-and-hold strategy, thus facing risks from exchange rate fluctuations, changes of local policies and laws, profit repatriation restrictions, etc. On the other hand, portfolio investment is conducted through purchasing foreign securities, which are more liquid. When facing loss, portfolio investors can promptly sell their holding securities, cutting losses in time. Moreover, portfolio investment is usually diversified across countries, industries and companies, also contributing to its lower risk.
Direct investment is less liquid than portfolio investment
Liquidity refers to the speed and ease of converting an investment into cash without loss. Apparently direct investment is much less liquid than portfolio investment. Selling a foreign enterprise often requires a lengthy searching for potential buyers and complicated negotiations, not to mention direct investors’ general reluctance of giving up control. While portfolio investors can conveniently sell their holding securities in organized exchanges and recover cash rapidly. Therefore, facing urgent capital needs, portfolio investment has significant advantages over direct investment.
In conclusion, direct investment and portfolio investment vary greatly in multiple aspects including purpose, control, risk and liquidity. Direct investment pursues long-term control while portfolio investment aims for financial gain. Direct investors obtain real control of foreign enterprises while portfolio investors get no control. Direct investment bears higher risks than portfolio investment. And direct investment is much less liquid than portfolio investment.