What Is Foreign Investment Risk?

Posted by Robert Cobean on May 16, 2022

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When Russia invaded Ukraine on February 24, 2022, the United States, European Union, and other countries announced sanctions on Russia. These sanctions ranged from banning investments in and exports to Russia, sanctioning the Russian central bank and freezing assets of high-ranking political officials. This, in turn, drove Russia to impose its own economic sanctions and measures on foreign investors with assets and capital in the country. All of this, in conjunction with Russia’s shuttered stock market and the ruble’s collapse, has harmed foreign investors with exposure to Russian assets.

The Russian-Ukraine conflict is an extreme example of foreign investment risk. But foreign investment risk exists whenever an individual or entity dedicates capital to another country. Such risk can take place among even so-called “safe” countries. As such, foreign investment risk (sometimes known as global investment risk) is defined as the degree of loss likely to occur when investing in countries outside of the United States. 

Understanding Foreign Investment

Simply defined, foreign investment focuses on capital flows traveling from one country to another. Foreign investments are typically divided into two categories.

  • Direct. Foreign direct investments are physical purchases made in a foreign country, such as plants, buildings, or equipment.
  • Indirect. Foreign indirect investments focus on acquiring positions in companies that might trade on a foreign stock exchange. 

Individual investors might put capital into foreign stocks or bonds to help diversify their portfolios or as an inflation hedge. But such investors generally have a high risk tolerance.

Types of Foreign Investment Risk

As we’ve noted time and again, there is no such thing as a risk-free investment. If you’re investing in U.S. assets, you could have exposure to business risk, systemic risk, or even market risk if investing in real estate.

This can also be the case with foreign risk investments. But these investments come with other types of risks, too.

Currency

Currency risk is also known as foreign-exchange risk or exchange-rate risk, and refers to currency fluctuations. Your investment might be tied to the value of the country’s currency, not U.S. dollars. As such, when you sell that investment and exchange the foreign currency into U.S. dollars, the exchange rate will determine your gain (or loss).

Politics

In early April 2022, a draft bill to nationalize assets belonging to “unfriendly” states was submitted to the Russian State Duma. “Unfriendly” states include the United States, the European Union, and Great Britain, as well as the “foreign citizens and legal entities,” as well as affiliates and people who are connected with these states. If the bill passes, it means Russia can seize the assets without compensation to the owners. So an American with a direct investment in a Russian factory would likely lose that money. Again, this is an extreme example of foreign investment political risks. But there is the possibility, especially in autocratic nations, that geopolitics could exert an influence on your investments.

Interest Rates

Each country has its own central bank. And each central bank has its own monetary policy. Just because interest rates might be stable in the United States (or more recently, changing), this doesn’t mean that the same thing is happening in other countries. Fluctuating interest rates can impact the value of a particular asset. Such fluctuations could lead to a foreign asset’s value decline.

Other Risks

One other foreign investment risk is lack of information. In the U.S., there is plenty of information on publicly traded assets (and many private funds as well). This might not be the case in other countries with more opaque rules and regulations. 

Then there is the potential lack of liquidity. While you might find that foreign investment appealing, there could be a limited demand from other investors for it. This could mean that selling the asset if you need the money could be difficult.

Investor Beware

None of the above is to suggest that foreign investments aren’t a good idea. There are good reasons why capital flows internationally. But as is the case with any investment, understanding the risks involved, and your own tolerance for that risk, is important before you direct your own capital toward that foreign stock, bond, or real estate.

This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice, meeting the particular investment needs of any investor. Realized does not provide tax or legal advice. This material is not a substitute for seeking the advice of a qualified professional for your individual situation.

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