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How Much Foreign Exposure Do You Really Have?

It may be more than you think.

Karen Dolan, 01/27/2011

Have an opinion? Express it ibn the comments section at the end of the article!

Globalization is old news. It's no secret that many of the largest and most successful U.S.-based companies, such as Coca Cola KO and Procter & Gamble PG, have appealed to consumers around the world for decades. Many more companies without as long a history doing business overseas have been recalibrating their strategies to achieve broader reach. The shift makes sense. As the U.S. economy has slowed and competition has remained fierce, many firms have turned to emerging-market economies for growth.

However, by simply looking at the commonly reported "% foreign" statistic for funds you own, you wouldn't necessarily be able to tell that certain U.S. companies are highly dependent on international growth. That figure tells you where the companies held in the portfolio are domiciled, but not where they make their money.

I took a look at three prominent large-cap domestic-equity funds (Oakmark Select OAKLX, Clipper CFIMX, and Longleaf Partners LLPFX ) to see where the companies they own earn their revenue. To help limit the number of annual reports I had to scour, I chose concentrated funds and hunted down the geographic revenue breakdown for all of the companies they held. I found inspiration in a Fund Spy penned by my colleague Mike Breen in 2007, in which he first investigated this issue. Pat Dorsey also looked at the entire S&P 500 through this lens in January 2010 and found that 40% of the revenues came from outside the U.S.

Of the three funds considered, Oakmark Select OAKLX had the highest U.S. weighting by domicile (96%), but the lowest exposure by revenue (60%). Only three of the portfolio's 21 holdings record all of their sales in the U.S. Meanwhile, each of the fund's top five holdings collects more than one fourth of its revenues outside the U.S. Its top position, Discovery Communications DISCK, earns 35% of revenues overseas. Although U.S. consumers know the company for its successful cable TV programs such as the Discovery Channel and Animal Planet, what they may not know is that those very same brands are distributed across most markets with pay-TV offerings. Another holding in Oakmark Select's portfolio, Texas Instruments TXN, has rather strong brand recognition among U.S. consumers, but only sees 11% of its overall sales originate at home.

On the flip side, Longleaf Partners LLPFX had the lowest U.S. weight by domicile (83%) and the highest exposure by revenue (67%). The companies that grace the top of its portfolio are domiciled in the U.S., but also collect a large proportion of their revenues inside the U.S., helping to keep the revenue and domicile figures more in line with each other. For example, top holding DirecTV DTV earns 87% of its revenues inside the U.S., and top-five holding Walt Disney DIS earns 74% domestically. That's not to say the managers ignore the world beyond the U.S. Far from it, in fact: For two large holdings--Dell DELL and Yum Brands YUM--the managers have often stated that the companies' international presence is what's most appealing to them. Dell and Yum Brands earn 47% and 60% of revenues, respectively, outside the U.S.

Clipper CFIMX is an interesting case. When Mike Breen first looked at this issue in 2007, he also studied Clipper's portfolio. At that time, the fund was 100% invested in U.S.-domiciled companies and he found that 65% of its underlying revenues were coming from the United States. As of its most recent portfolio, the fund held 86% in U.S.-domiciled companies, but the cut of foreign revenues remained steady at 65%. One might say that the fund has transitioned to a much more global posture over the past four years, as it now owns more companies domiciled outside the U.S., but in reality its global exposure has remained the same.

While border lines are blurring, investment performance does still correlate with home markets. Thus, it's still important to view your domestic/foreign exposure through traditional lenses. For example, India-based Infosys INFY reported that 65.8% of its revenues originated in the U.S. for its fiscal year ended March 2010, but its stock is largely still driven by what's happening in the India market. Currency effects alone mean that where a company trades does have a substantial impact on stock performance.

In short, it is instructive to consider where companies you're exposed to do business alongside understanding where they are located. Morningstar is collecting and storing geographic exposure by revenues, but the data isn't reported in a uniform way. Furthermore, there is nothing even close to a standard among foreign-domiciled firms. But we are exploring ways to overcome these hurdles and hope to bring more systematic clarity to the geographic breakdown of stocks and funds in the future.

Karen Dolan is Morningstar's director of fund analysis.

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