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Foreign Portfolio Investment (FPI) in Ukraine, Poland and UK

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. In this paper we are going to concentrate on portfolio investment and compare investment opportunities in three chosen countries, particularly, Ukraine, Poland and UK. Moreover, we are going to include positive or negative recommendations concerning certain type of investment.

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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.

There are several classifications of investors that we will use further in this paper. Firstly, investors are divided on those who invest for short-term gains (few days, weeks, months – up to 1 year) and long-term profits (more than one year). Furthermore, investors can be separated by risk tolerance, mainly, risk-seeking, possessing aggressive investment strategies (ready to take risk for possible higher returns), risk-neutral (consider only expected return from an investment) and risk-averse, or conservative, (look for “safer” investments even if return is low).

To be more precise, as investors have the common goal of increasing the value of their portfolios (grow invested capital), it is essential to understand the investment risk pyramid (Figure 1). It visually shows that greater risk brings higher rewards.

Figure 1. Investment Risk Pyramid

C:UsershomeDesktopInvestment risk pyramid.png

Source: “Taking control”, Wells Fargo Advisors Guide

Considering the choice of countries which were selected, the main criteria were the degree of state’s safeness (how risky it is to invest in particular country) and, consequently, the amount of return which can be gained. Ukraine is a country from post-Soviet space which goes through a long and harsh period of transformation to become a European economy. This country is characterized by political instability, feeble economic performance; however, frequent and considerable fluctuations in, for example, exchange rates might bring high returns for lucky investors. Poland also was under Soviet burden, hopefully not for a long period of time, which saved it from many undesirable effects in country’s economy. Moreover, Poland joined EU in 2004 which had a positive effect on country’s economic performance and overall macroeconomic situation. Poland is characterized by gradual, but stable growth and expansion of the economy, offers insignificant fluctuations in main macroeconomic indicators and is considered to be 4th in Europe and 14th world most attractive economy for investments according to UNCTAD “World Investment Report 2013.” The UK financial market is considered to be one of the most stable and offering sustainable returns (5th world most attractive economy for investments).

In order to evaluate overall risks, connected with the investments in chosen economies in general, investors will check credibility of the country. The credit ratings of chosen countries are represented on the table below (Table 1).

Table 1. Companies’ credit ratings

Rating Agencies S&P Moodys Fitch
Ukraine CCC Caa3 CCC Extremely speculative
Poland A- A2 A- Upper medium grade
Great Britain AAA AA1 AA+ Prime/High grade

Source: Authors own elaboration based from data from Trading Economics

Credit ratings of the countries, according to main rating agencies clearly show the difference between Ukraine, Poland and the UK. Due to the fact that Great Britain has the highest possible credit ratings, it implies that risk-averse investors would seek possible ways to invest own capital in the capital market of the UK. Polish economy seems to be more risky than British, however, less risky than Ukrainian one, which has extremely speculative grade from rating agencies.

On the table below one can observe the main factors influencing portfolio investors’ decision (Table 2). The set of chosen control macroeconomic variables includes short-term interest rates, stock market indices’ volatility, fluctuations in real effective exchange rates, GDP growth and taxes on capital gains. We will also make an assumption that investor is going to invest in US dollars.

Table 2. Main factors influencing portfolio investors’ decision

2007 2008 2009 2010 2011 2012 2013 Gov. Bond yield (1year)
Ukraine 20%
Exchange rate volatility(average) 2,85% 16,56% 35,06% 8,29% 4,36% 4,53% 8,30%
Short-term interest rate 8% 11% 10,5% 8,6% 7,5% 6,7% 9,5%
Market UX index volatility (average) 26,65% 38,43% 47,36% 37,71% 31,30% 35,68% 22,78%
GDP Growth 7,9% 2,3% -14,8% 4,2% 5,2% 0,2% -1,6%
Tax 18% 18% 18% 18% 18% 18% 18%
Poland 2,58%
Exchange rate volatility (average) 8,96% 15,54% 26,97% 19,64% 16,89% 16,00% 10,97%
Interest rate 4,64% 6,11% 3,88% 3,61% 4,37% 4,77% 3,02%
Market WIG index volatility (average) 23,13% 30,20% 40,18% 22,91% 18,70% 21,78% 15,90%
GDP Growth 6,8% 5,1% 1,6% 4,1% 4,5% 1,8% 0,9%
Tax 19% 19%% 19% 19% 19% 19% 19%
Great Britain 0,42%
Exchange rate volatility(average) 6,12% 10,21% 16,23% 10,23% 8,48% 7,46% 6,98%
Interest rate 5,86% 5,18% 0,82% 0,56% 0,65% 0,62% 0,49%
Market FTSE 100 index volatility (average) 17,49% 28,05% 37,22% 19,66% 20,01% 20,29% 12,40%
GDP Growth 3,4% -0,8% -5,2% 1,7% 1,1% 0,3% 0,7%
Tax 24% 23%

Source: Author’s own elaboration

Among three analyzed countries Poland has the highest average GDP growth rate (for the period of 6 years it never descended lower the zero) amounting to 2.4% average over 2011-2013 (it exceeds Ukrainian by almost twice and British by more than 3 times), thus, we can say that economy possesses growth opportunities. GDP growth rate is fluctuating, nevertheless, country’s economy is expanding and portfolio investors may benefit from Poland’s growth potential. The UK as a mature and developed country possesses low growth rates. Ukrainian GDP growth rates are extremely fluctuating. This economy suffered most among others during the Global financial crisis (almost -15 percent shrinkage), nevertheless, there was positive growth in 2010-2013; however, GDP growth rate over again fell below zero in 2013.

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At the same time portfolio investors are interested in stock market indices to track the markets’ changes over long periods of time and use it as a benchmark against which to compare their own portfolio returns. Except of the crisis period of 2007-2009 when all three indices showed extremely high volatilities, the UK FTSE 100 seemed to be more stable than two others. However, in 2011 Polish WIG20 showed 1.30 percent less volatility than UK FTSE 100, which can be interpreted by the second wave of the crisis. Ukrainian UX index had a decreasing tendency since 2009 and in 2013 volatilities amounted to almost 23 percent up or down.

Taking into account the fact that usually government bond yields serve as a lower bound for considering capital market yields, the assessment of the chosen economies will be built using the return on government bonds as a benchmark. Nevertheless, when new bonds are issued, they normally have coupon rates at or close to the normal interest rate on the market. Thus, interest rates and bond prices have a kind of inverse relationship: when one goes up, the other goes down. Since investors continuously compare the possible returns on their current investments to opportunity cost (the one which can be received elsewhere in the market) changes in interest rates, which are not fixed like bond coupons, influence the attractiveness of the bond. Moreover, variations in the short-term interest rate may be perceived by investors as a change in monetary policy and an increase (decrease) in interest rates pushes stock prices and yields to maturities down (up), which immediately results in portfolio outflows (inflows).

Ukrainian government bonds have the highest return of 20 percent per year which is about two times higher than market interest rates. Till 2012 interest rates were gradually decreasing pushing stock prices and yields to maturities up. However, in 2013 short-term interest rate surged by almost 42 percent. We can conclude that Ukrainian government tries to attract money in the economy offering enormously high returns on government bonds. Speaking about Poland, bond coupon rate is lower than interest rates which mean that investors are more willing to put money elsewhere than in Polish government bonds. In the UK the spread between interest rates and government bond coupon rate is the smallest within the analyzed companies which signifies the stability and reliance of financial market.

Moreover, sudden and unexpected fluctuations in exchange rates affect foreign investors’ returns in their own currencies. Volatilities of Ukrainian exchange rate to USD does not seem to reflect the risks, connected with possible adverse exchange rate scenarios, as the volatility over 2011-2013 period amounted to about 6%. In turn, Poland has greater exchange rate volatility amongst all three countries. Possibly it could be connected with the exchange rate regime in Ukraine that is not floating, but fixed by Central Bank’s reserves (such policy is adopted to attract FDI to the country), while British pound is the most stable currency.

To generally conclude, Ukrainian market is perceived as volatile and risky, thus, it is not recommended for long-term or significant investments. However, speculative or risk-seeking investors might invest in Ukrainian market for a short-term period (even daily trading). Moreover, investors knowing some insider information (for example, having contacts with high standing officials) can make huge profits on investing in government bonds or gain from fluctuations in exchange rates.

Poland represents average risks for the FPI investments, however, having much lower possible minimal return on investments. Nevertheless, positive evaluation from rating agencies, GDP growth perspectives, medium volatility of market indices, all these signifies the profitability of Polish market. Poland will be the best solution for the investors, which tolerate some risks, but do not agree to gamble on greatly volatile Ukrainian market.

The United Kingdom, as the most developed economy among chosen countries, is the best choice out of three countries for investors who look for stable investment place, without excessive risk on investments. Risk-averse investors will be reluctant to adding stocks or investments with high-risk to their portfolios. In turn, they will stick to “safer” investments like government bonds and index funds, which usually bring lower returns.














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