The 'new geography' of investing

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Financial advisers know investing in broad market indices may inadvertently give rise to unexpected geographic exposures, but perhaps not to the extent shown by new analysis released by fund manager Capital Group.

Consider using economic exposure to map portfolios instead of the traditional method of country of domicile, it says.

The research, published in white paper The New Geography of Investing: A paradigm shift in portfolio evaluation and construction, shows around 43% of revenues by companies represented in the S&P/ASX 200 Index are from outside Australia.

This trend is being mirrored in other developed markets.

In the UK, 77% of the revenues generated by companies represented in the FTSE 100 are derived from outside the UK. In the US, the companies in the S&P 500 Index derive 40% of their revenues outside the country.

At a global level, the MSCI All Country World Index is the broadest global equity index with 2500 companies. Emerging markets represent only 11% of the MSCI ACWI by market capitalisation, but 34% by economic exposure, or more than a third of all global demand.

At a sector level, it is similar for Australia’s top 200 companies. For S&P/ASX 200 Materials companies for example, their economic exposure in terms of percentage of revenues derived from outside Australia is more than 88%.

Using a company’s locale as a good proxy for where it does business, and thus its prospects, is increasingly out of step with today’s global economy, says Capital.

“Australian investors are well attuned to globalisation but they may need to change the way they view – and use – traditional stock market indices,” said Capital investment specialist Andy Budden.

“Our analysts’ approach is to look at where companies generate their revenues as a way of assessing their future performance, and share price growth prospects. We call this ‘the new geography of investing’.”

While this has not been possible before because companies do not tend to report revenues in enough detail, it is starting to change, Budden said.

“What we are seeing around the world now is that enough companies are reporting revenues by geography. This is giving us a much more accurate picture of not only what is driving their revenues, but where they’re coming from.”

The revenue versus domicile debate is especially acute for investment vehicles based on geography, including many of today’s most popular index funds.

“Investors in a portfolio that replicates the S&P/ASX 200 might not get the Australian concentration they’re seeking, given that approximately 43% of revenues generated by companies represented in the S&P/ASX 200 come from outside Australia,” said Budden.

“Basing your investment decisions on where a company gets its post delivered is simply no longer the best approach.”