Equity investors who look at indexes based on revenue rather than domicile will discover an entirely different investment universe, according to a HSBC Bank report.
Global indexes are based on domicile. The MSCI U.K. Index, for example, is composed of companies from the U.K. But as two-thirds of their revenue comes from overseas markets, the index isn’t really providing investors with exposure to the U.K., HSBC analysts wrote in a new report.
All the companies in the Dow Jones Industrial Average are based in the U.S., but more than 40% of the overall revenue is derived from outside the U.S.
At the same time, companies are inconsistent in their disclosures of where they generate their revenue and accounting rules don’t help. Combined, those factors mean that understanding where revenue is made is a “fertile ground to add value,” they wrote.
“By looking beyond locally listed stocks incorporated in the country benchmark, analysts can broaden the universe of potential investments,” said the report. “This often gives exposure to harder-to-access sectors and countries.”
The report analyzes 29 major developed and emerging country indexes and outlines ways to play both GDP and currency trends. It found that European companies are the most global, generating almost half their revenue overseas. At a time when global economic growth rates are weak and risk perception high, that has led many European indexes to underperform. Europe’s big exposure to emerging markets (EM) on the other hand, has been a positive, as EM markets have stabilized.
The U.S. is the most closed of the developed markets (DM), a trend that has accelerated as the dollar has strengthened. That has helped cement the U.S. as a safe haven. Japan, in contrast, has become more open, although that trend may reverse as the yen strengthens.
Economies and equity markets “are not created equal,” the report said. European equity markets are very open compared with their economies.
“The share of overseas revenues of French, Italian and Swedish companies far exceeds the share of exports in GDP. By comparison, EM stock markets are much more closed than their economies, led by Asia,” said the report.
Other findings include:
• DM companies with EM exposure are looking cheap, relative to historical levels.
• EM companies with high DM exposure were relative havens in the past few years, but that strength is expected to wane.
• Globally diversified companies may benefit as the correlation between regional growth and currency volatility increases.
• Brazil, Russia, Canada and South Africa are expected to have the biggest GDP recoveries into next year.
• China is becoming more international, as its companies look for opportunities outside their national borders. Chinese companies generated just 10% of their revenue overseas in 2015, up from 8% in 2010.
• Italy and India have globalized the most. Italian companies generated 73% of their revenue overseas in 2015, compared with just 59% in 2010. Indian companies generated 41% of their revenue overseas in 2015, up from 28% in 2010.
• DM companies are far more global then EM companies. Switzerland is the leader, generating 88% of its revenues outside of its own market, followed by Sweden at 84% and the Netherlands at 81%.
• The most domestic markets are all in EM, led by Indonesia, with just 4% of revenues stemming from other countries. The Philippines comes second with 9% of revenue overseas and Turkey is third at 10%.