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Follow the Money to Understand Your Stocks' Real Exposures

Knowing the sources of a company's revenue, not just its country of domicile, is important for investors to get the actual exposures they want, says American Funds portfolio manager Rob Lovelace.

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Janet Yang: I'm Janet Yang with Morningstar. Today I am at the Morningstar Investment Conference with Rob Lovelace from Capital Group, The American Funds.

Rob, thank you for joining us today.

Rob Lovelace: Real pleasure. Thank you for having me.

Yang: You and your team have been doing some pretty interesting research looking at your funds and your portfolios and their country exposure, not necessarily by their country of domicile, but from where their revenues are coming from. Can you tell us a little bit more about that research?

Lovelace: Absolutely. We're referring to it as the new geography of investing. It really is recognizing the fact that, back in the '60s and '70s, where a company was based, where it was listed, was a really good proxy for where it did business. We all know that the world is globalized, and I think everyone's aware that most companies do some business abroad, and I think in the '90s and 2000s, it still was a minority of the total revenue of the company that came from other countries.

But really in the last 10 years, things have changed to the point where we probably need to start paying attention to it now. And that's the work that we have been doing, and that's what the new geography is about, which is finding a new proxy for thinking about where a company does business. You can think of lots of examples--the auto companies are probably the easiest ones--of companies that are based in Japan, but do a majority of their business in the United States, or that are based in the U.S. and are one of the biggest auto producers in China, or based in Europe and do business everywhere, except maybe not so much in their home country.

So, what's the best way when you're looking at your portfolio to think about the actual exposure of that company? Where a company is listed still matters. That has an impact, obviously, on the currency in which the stock is denominated, maybe their liabilities, and certainly investors in that country will look at it that way and what index they are in. But you can look at the revenues now--companies are reporting it in a way that actually gives you enough information.

So we think revenue is the best new proxy for where a company does business, and we're working on developing standards so that can be part of normal reporting.

Yang: Can you give us an example, maybe one that an investor would find surprising, in terms of where it's domiciled versus where its revenues are actually coming from?


Lovelace: There is a long list of these. I think starting at a bigger level and bringing it down, if you look at Europe, it might surprise, it might not surprise, people to realize that actually in the European index, more than 50% of the revenue of the companies on the index comes from outside of Europe. I think part of that speaks to where growth has been in the world. Growth has been in the United States, growth has been in emerging markets, and those companies have very logically shifted toward that.

And if you look at the oil companies, it probably wouldn't surprise people that TOTAL and other firms get a majority of their revenue from outside of their home countries or the country of listing. But Nestle, which is the largest index component, actually gets a majority of its revenue from outside of Europe. A lot of the pharmaceutical companies, again, that are in the top 10 there, get most of the revenue from the U.S., and then also an important component from emerging markets. These are the types of stocks that I think catch people's attention.

Another example, when we were looking at the U.S. recovery, I think everyone would think of investing in Home Depot; as construction comes back that's a really logical place to go. But they might not think of a Hong Kong-listed--and therefore classified as a Chinese company--Techtronic, which happens to be the number-two power tool maker both in the professional and individual power tool markets.

You would miss these opportunities if you limited yourself just to the country of domicile in terms of thinking about how to benefit from a growing U.S. economy. Or how do you really get at a European recovery if most of the companies there do business outside of Europe?

Yang: That's really interesting. Maybe we can connect that idea to one of the portfolios where you're a manager, American Funds New World. At least our data shows that the emerging-market stake seems to have been coming down from its historic norms. What does your revenue source [data] show about that fund?

Lovelace: The New World Fund, just to remind everybody, is a fund that focuses on the emerging-markets opportunity, and it was created 15 years ago already with this initial idea that we need flexibility in country of domicile when we think about the emerging-markets opportunity.

Specifically, the emerging-markets-domiciled companies, the ones listed in those countries, tend to be very overweight or overexposed to the commodity companies, banks, and telecoms. And when I think about investing in developing countries and emerging markets, what I'm excited about is the consumer opportunity--rising living standards. It's both consumer stocks as well as infrastructure.

And I bet if I said to you, you're excited about emerging markets, I'm going to give you a bunch of commodity producers, you'd probably say, no, no, no; that's not what I'm interested in at all. I want branded goods. I want pharmaceuticals and rising health care. I'm interested in technology, particularly branded consumer aspects of it. Those are the pieces you'd want. Those three sectors--technology, health care, and consumer--are underrepresented in the companies listed in the developing world.

So, New World Fund was specifically designed to give us flexibility to invest in companies wherever they are based that do a substantial amount of business in emerging markets.

What you're referring to is, in the fund, the exposure to companies specifically listed in those countries is going down, while our exposure to those listed outside but doing business there is going up. What that would tell you is, the big index components of those based there are the state-owned enterprises--generally oil producers in Russia, in Brazil, in China; big banks, generally in Russia, Brazil, and China--and we're less excited about those. What we're more excited about is rising auto consumption in China, and the way to get at that is, interestingly, not so much through the Chinese brands, because the Chinese auto companies are still developing a national brand, they're still trying to figure out what they want to be. But the Koreans, the Japanese, General Motors, the Germans are the ones building factories in China and taking advantage of that exciting opportunity.

When you break it down to the specific company level, what we're finding is, these are the better ways to get at that fast-growing consumption. Even if you're worried about the Chinese economy, the auto market there is going to continue to expand, and it's generally companies domiciled outside of China that seem to be the ones benefiting from it. That's an example of why you're seeing that shift.

Yang: That's some really great food for thought, and it was a pleasure. Thank you very much for joining us today.

Lovelace: Thank you. I really appreciate the questions.

Janet Yang Rohr, CFA does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.