By Rob Lovelace
Geography is a key building block for investors, whether they’re individuals buying index funds or professional money managers thinking about asset allocation or building portfolios. Unfortunately, investors may be undermining their results by making decisions based on an assumption that is becoming increasingly less relevant.
Investors historically have used a company’s locale as a good proxy for where it does business, and thus its prospects. Today, though, where a company is domiciled tells investors little about its potential for success. While this is an issue facing all investment managers, it is especially acute for investment vehicles based on geography, including many of today’s most popular index funds.
Capital Group created what is now known as the Morgan Stanley Capital International (MSCI) indices(1) in the late 1960s from data we gathered while doing global research on individual companies. At that time, with only 18 countries available for investing and five of them accounting for 90% of the opportunities(2), where companies were based served as a good proxy for where they did business.
The world has changed dramatically since then. Today, where a company is located often has little to do with where it generates its revenues or profits and tells investors almost nothing about its prospects.
Consider these examples: Priceline is based in the United States, but generates 63% of its sales in Europe. Sun Pharma is domiciled in India, but generates 54% of its revenues in the United States(3), where it sells more than 200 generics. Is Priceline a US company? Is Sun Pharma an emerging market company?
Even broad and well-known indices don’t always provide a clear picture. While it’s well known that UK companies operate in many countries, do investors realise that fully 77% of the revenues generated by FTSE 100 companies come from outside the UK?(4) Or take the broadest global equity index, the MSCI All Country World Index, comprising 2500 companies. While emerging markets represent only 11% of the index by market capitalisation, they account for 34% by economic exposure. At the same time, the US accounts for 49% of the MSCI ACWI, but only 28% of revenue( 5). Investors who rely on these geography- based indices may be inadvertently misallocating their portfolios.
There is a better approach; something we call The New Geography of Investing – looking deeper than where a company is headquartered to where it generates its sales and by extension, its profits.
How can investors use The New Geography to focus on companies that may offer the best opportunities? First, investors need to rethink how they define a company’s geography, because using a revenue lens means that a company is no longer from one place. Second, investors need to be clear about what they want to achieve. Whether it is growth, a steady income stream, or preservation of capital, investors’ objectives will be the new organising principle, not country of domicile.
The old geography served us well for many years and remains useful. But for stock selection, asset allocation and overall portfolio construction, we should focus our attention on companies with the brightest prospects, no matter where they are domiciled. The New Geography of Investing gives investors a better opportunity to reach their long-term goals, and isn’t that the whole point of investing?
1) MSCI indices are now maintained by MSCI, Inc.
2) Source The Capital Group Companies
3) Source: Capital Group analysis using MSCI Economic Exposure Analysis – Security Report. As at 30 June 2013.
4) Capital Group analysed 98.65% of the FTSE 100 index. As at 30 June 2013.
5) MSCI. As of 30 June 2013
Rob Lovelace is director and portfolio manager at Capital Group
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