But to investors, Paris, Texas and Paris, France may not be that different after all.
For years, investors have been trained to look at their asset allocation using the proverbial pie chart, with one slice of the pie devoted to big U.S. stocks, one slice to international stocks, and so on.
But today’s cross-border multinationals are making it much harder to tell which company speaks business with a French accent and which is speaking with a Texas twang.
For years, we’ve classified companies as “U.S.” or “international” based on where the company’s headquarters were located. We’ve always assumed that “U.S.” companies and “international” companies operate on different business cycles, and by combining both in your portfolio, we can improve diversification and enhance returns.
But new research from American Funds’ parent company Capital Group, which manages over $1 trillion and was a pioneer of international investing, says this way of dividing up the world no longer makes sense.
Today’s trade patterns call for a new way of seeing the world. Capital Group says a better way to classify global companies is by where they actually do business and make money, rather than where they’re based.
“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,” says financial writer James Picerno, who interviewed Capital Group execs for Financial Advisor magazine.
Here’s some examples that make Capital Group’s point.
Example #1. Burberry, designer of the iconic trench coat and other luxury goods, is a British company. True or False?
Arguably false. Using the traditional rule book, Burberry is indeed British. But less than 1/3 of all sales are booked in Europe, and according to Capital Group, the company “caters to more consumers in the U.S. and in Emerging Markets than in Europe.” Fully 40% of its revenues come from rapidly growing sales in the Asia Pacific market. So if you expect Burberry to act like a traditional British or European company, you would be wrong. You might be surprised to see Burberry’s growth track Beijing more closely than Brussels.
Example #2. Sun Pharma, based in Mumbai and one of India’s biggest manufacturers in the generic drug industry, is an “emerging markets” stock. True or False?
Likely false. Sun Pharma sells over 200 generic drugs and earns more than half its revenues in the USA. That’s why its stock may have more in common with U.S. business cycles than economic trends in emerging markets. If you buy a stock like this to gain exposure to emerging market growth trends and cycles, you may be disappointed.
Example #3. The company with the second largest share of the power tool market in the U.S., and a key supplier to Home Depot, is American. True or False?
Definitely false. Techtronic is based in Hong Kong, and makes Hoover, Ryobi, Dirt Devil and other brands. With big sales in the U.S., it may correlate more closely to the S&P 500 than foreign indexes.
Example #4. Which company will benefit most from a European recovery – Nestle (the largest company in the European stock index, based in Switzerland) or Priceline (based in Norwalk, Connecticut)?
Believe it or not, it’s Priceline, which books 62% of its sales in Europe, versus only 25% at Nestle, which is more closely aligned with emerging markets.
The Takeaway: Using the old math, over one-half of all investment dollars are allocated to companies headquartered in the USA. But only 30% of actual business revenues are generated within the U.S., meaning investors may be allocating too much to U.S. markets.
Emerging market companies have captured only 11% of world investment dollars, but their markets generate over 1/3 of global revenues, more than North America. That means investors may have too little stake in these up-and-coming countries.
The solution? Investors looking for growth should focus on those companies – whether based in the U.S., Europe, or emerging market – that successfully target growing, profitable opportunities in emerging markets.
Of course, that’s easier said than done. It’s still hard to know how to measure and evaluate investment opportunities across the globe due to global accounting conventions and imperfect data. But it certainly pays to keep an open mind and look at what companies do and where they sell rather than where they’re located.
Last minute portfolio advice from Capital Group: Think globally, be flexible, and avoid getting pigeonholed into narrow country allocations. Consider devoting more space in your portfolio to global opportunities, divvying up your pie chart by purpose and function rather than geography.