Investing in companies around the world as a tool for broadening opportunities and managing risk is an old idea that still relies on an even older technology: maps. But as globalization rolls on, the economic value of national borders for designing portfolios continues to fade. That’s old news, although many investors may be shocked to learn just how different the world looks when analyzing companies and markets through the lens of what some call the new geography of money management.
“Investment benchmarks based on domicile may not be as useful as they once were,” says David Polak, a veteran equity specialist and senior vice president at American Funds’ parent Capital Group, which manages over $1 trillion. Instead, he recommends crunching the numbers based on where the revenues are generated for analyzing companies and stock markets around the globe. In other words: follow the cash flows—and ignore or at least minimize the knee-jerk habit of allowing lines on a map to dominate your plans for investing overseas.
The conventional approach of using political boundaries to define multinational portfolios was compelling before the current wave of globalization reshuffled the standards of investment analysis. Once upon a time, a company’s base of operations told you most of what you needed to know for evaluating stocks. But from the late 1990s on, industry and company-specific factors started to cast more influence over equity prices.
As a recent research paper from the Capital Group says: “The economic world today is structured differently than it was just two decades ago. Free-trade agreements, the European Union and its common currency, economic reforms and the rise of a middle class in Asia, Latin America and parts of Africa [have] allowed companies to compete for customers, labor, capital and natural resources on a global basis. Average tariffs have declined from 26% in 1986 to 8% in 2010. Exports as a percentage of GDP have grown to almost a third of global activity, compared to 20% in 1994 and 15% in 1973. Economies are more closely linked than at any time in history.” (From Investment Insights, April 2013.)
It may be obvious in 2014 that people would want to design a global equity strategy that reflects the changing macroeconomic landscape, but such a strategy hasn’t always been easy to implement. The lack of data was one past obstacle, but corporate reporting standards have caught up with the economic evolution of the last two decades. More companies around the globe routinely publish local sales and earnings and other financial information.
“We’ve reached the point where the majority of companies break down their revenues by region,” observes Polak.
Think Globally, Invest Locally
The combination of an increasingly globalized economy and the availability of detailed accounting data opens up a brave new world of multi-factor possibilities for equity investing. Consider two examples: Burberry Group and Sun Pharma. At first glance, these publicly traded companies appear to be representative of their home countries and regions. But a closer look reveals a more nuanced profile.
Let’s start with Burberry, the iconic British apparel company based in London. On the surface, it’s one more U.K. company, so a naïve investor might assume that it’s closely tied to the ebb and flow of England’s economy. The shares certainly look British, in part because the stock is among the holdings in the FTSE 100, the popular U.K. equity index that claims some of the biggest names on the London Stock Exchange. But appearances can be deceiving in the 21st century.
Less than one-third of Burberry’s revenues come from Europe. By contrast, the Asia-Pacific market accounts for nearly 40% of revenues, followed by the Americas, which generate roughly a quarter of Burberry’s sales. In fact, growth beyond Europe is expected to remain a critical factor. The firm projects sales will rise 13% in the Asia-Pacific region, a bit more than twice as fast as the pace of growth in its European operations.
Is Burberry a British company? It all depends on how you define “British,” although the numbers suggest that its fortunes will be largely determined by distinctly non-British trends.
Meanwhile, it’s easy to see Sun Pharma as a classic “emerging markets” stock. Based in Mumbai, the company is one of India’s biggest pharmaceutical players in the generic drug industry. But here again the initial view is misleading: More than half of sales originate in the U.S. The Subcontinent is the company’s home base, but India accounts for just one-quarter of revenues. If you expect U.S. generic drug sales to rise in the years ahead and you’re looking for a company to ride the wave, Sun deserves consideration.
Emerging Weights
What’s true for individual companies applies to stock markets. Consider how the major equity-market regions of the world compare from two perspectives: market capitalization and revenues. Using the yardstick of total share value, North America (which is dominated by the U.S., of course) holds a bit more than half of the global opportunity set: 51% of market cap, according to Capital Group’s analysis of MSCI indexes (see Figure 1). Stocks in the emerging markets are minnows by comparison with a mere 11% of the planet’s market cap (in U.S. dollar terms).
Those figures shift dramatically, however, when measured through a revenue prism. Emerging markets generate roughly one-third of global revenues (based on the MSCI All Country World Index), or a bit more than North America’s share.
The lesson for designing equity strategies: Looking at the world through revenue-tinted glasses tells us that emerging markets—India, China, Brazil and the like—deserve roughly the same weight as U.S. equities.