Does home country bias affect investor returns?

As the world's biggest blue chips are thoroughly global, they cannot help being affected by what happens internationally

John Rekenthaler 27 February, 2019 | 6:00PM

Equity portfolios can't help being global. Multinationals account for most stock market assets, and they sell their wares everywhere. Where a blue-chip company is headquartered does not indicate its revenue sources.

According to Morningstar's latest calculations, 62% of revenues for S&P 500 companies come from the United States. As S&P 500 firms account for 80% of the capitalisation of the Wilshire 5000 - which reflects the majority of U.S. traded stocks – that index scores similarly. Consequently, shareholders of major U.S. stock market index funds have about 40% foreign exposure, as measured by corporate revenues.

Unsurprisingly, given that the U.S. is easily the largest consumer market, this figure is above other countries'. Japan and Australia are close, with 59% of the Nikkei 400's revenues arriving from inside Japan, and 58% of the S&P/ASX 200's revenues being from Oz. However, the United Kingdom's amount is far lower, with domestic revenues of 22%.

Which is the highest figure calculated by Morningstar in Europe. As the UK is realising, no European country is anything resembling standalone. Almost all the continent's major companies operate mostly across national borders. Just under 20% of revenues for companies in Germany's DAX index are local; for France's CAC 40 index the figure is 17%.

Everywhere, the home-nation percentage rises as the companies shrink. In the US, 81% of the revenues for the long-standing small-company stock index, the Russell 2000, are domestic. In the UK's small company indices, the figures are roughly 50%, and in Continental Europe they are 30% to 40%.

U.S. is split between home and overseas

With some effort, U.S. investors could largely avoid exposure to foreign revenues. In practice, however, the customary portfolio of 1) a core of U.S. blue-chip stocks surrounded by a smattering of 2) U.S. small-company equities and 3) overseas issues leads to an overall revenue mix of roughly 50/50. In other words, most American fund shareholders are halfway dependent on the kindness of strangers.

Industry exposures vary widely. Companies in sectors that have the most-diversified revenue streams – ranging in the U.S. up to 85% for semiconductors – make things: chips, phones, soap, plastics. Such items can readily be shipped. In addition, most can be built elsewhere, cost effectively. Coca-Cola (KO), for example, owns 57 manufacturing plants in India. That the firm is based in Atlanta is immaterial to its business.

In contrast, those with the highest local percentages tend to purvey services, which neither fit into packages, nor into cargo holds. Moving electricity is difficult, and while sending natural gas abroad can be accomplished, doing so while retaining control of the product generally cannot. Consequently, 97% of U.S. utilities' business is generated within the 50 states. Telephone services, banking, and transportation also tend to be local.

Does Diversity Boost Performance?

The question arises: how do the sources of a revenue stream affect a stock's returns? For example, if a company based in the US generates 50% of its sales at home and the other 50% in Europe, will its stock move in tandem with the stock of a European company that shares its industry and revenue mix? Or, will the location of their domiciles send those two stocks scurrying in different directions?

Morningstar has yet to study that subject, and because the global data are only now becoming available, neither have many academic researchers. This field has not been well-explored. I suspect the answer is: it depends.

For one, the studies will be difficult to conduct. No two companies have identical revenue streams, and no matter how closely their businesses resemble one another's, there are still large discrepancies, which must somehow be considered in the calculations. Controlling for all relevant effects will be a chore indeed, and will make the resulting estimates loose rather than precise.

For another, the truth likely falls somewhere in the middle. Researchers have documented that even in the simple, obvious case wherein the same company's equity is dual-listed and available for sale on two countries' stock exchanges, its performance reacts to its whereabouts. The two versions of the shares do not move in lock step, although both logic and conventional financial theory suggest that they should.

The world's blue chips sway to their home country's winds. However, as their businesses are thoroughly global – aside from certain services companies – they cannot help but to be affected by what happens elsewhere. The giant firms that dominate the stock indices offer substantial international diversification, whether the investor desires that attribute or not.

Famously, Jack Bogle maintained that U.S. investors did not need to hold foreign stocks. He offered several arguments besides what this column has given, including the claim that U.S. dollar-based liabilities should be supported by U.S. dollar-based assets. But one of his key contentions was that international diversification comes out in the wash, because big business is global. Morningstar's recent release supports that point.

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John Rekenthaler

John Rekenthaler  John Rekenthaler is Vice President of Research for Morningstar.