Diversifying in a Shrinking World

Turbulence in domestic stocks has exacerbated debate over how much foreign exposure a portfolio needs. A few decades back, it was simple. Investors dedicated a set percentage of their portfolio to foreign-domiciled firms and received proportionate exposure to foreign economies. Not anymore. Globalization has blurred the lines. A firm's address is no longer an accurate indicator of where it does the bulk of its business.

A peek at the major benchmarks illustrates this point. Recent research estimates that nearly 45% of the S&P 500 Index's underlying revenue comes from outside the United States. Data is tougher to come by on the main foreign index, MCSI EAFE, but I piled through the footnotes of enough foreign annual reports to see that a similar global trend exists in that index as well. Just as many U.S. companies derive a big share of their revenues from overseas, so do foreign firms earn a big share of their profits from outside their home market.

This trend got us thinking about the impact on investors. So, we dug into the financials and found that labeling firms domestic and foreign based on their domicile isn't always an accurate indicator of their economic reality. The effect on a portfolio can be meaningful, so investors need to dig beneath the surface to understand the true geographic makeup of the firms a fund holds.

It's Not Where You're Located
There are clear similarities in the upper reaches of both benchmarks. The top firm in the S&P 500 is Exxon Mobil XOM, while British Petroleum BP grabs the same position in EAFE. Both oil companies generate about 30% of their revenue in the U.S. and the remainder around the globe. Nearly all major oil firms have similarly global profiles--regardless of domicile or which index they call home.

The story is the same with big drug makers. GlaxoSmithKline GSK, Roche RHHBY, and Novartis NVS are foreign-domiciled members of EAFE. Johnson & Johnson JNJ, Pfizer PFE, and Abbott Labs ABT are U.S.-based constituents of the S&P 500. All six firms generate close to half their revenues in the U.S. and the remainder around the globe. Similar patterns permeate both benchmarks.

Foreign Exposure at Home
Digging into the S&P 500's holdings revealed a few surprises about the extent of its constituents' foreign operations. I was aware that such U.S.-based firms as Coca-Cola KO and McDonald's MCD had a big global presence. But chipmaker Intel INTC garnering nearly 80% of its sales abroad was news to me. Ditto for computer maker Hewlett-Packard HPQ: It hauls in two thirds of its revenue abroad.

On the next page is a sample of firms with prominent positions in the S&P 500 that also have with big foreign-revenue streams.PAGEBREAK 

U.S. Companies with Overseas Revenue
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