The location of a company's headquarters doesn't tell the whole story.
Over the past 10 years, domestic large-cap funds' regional exposure has changed quite a bit. In mid-2001, 99% of the typical U.S. large-cap fund's portfolio was invested in stocks domiciled in the United States. In July of this year, that level dropped to 92%. This drift reflects relaxed mandates and domestic-fund managers' increasing willingness to hunt for stocks outside the U.S. And to some extent, it highlights the hunger for higher growth rates found in many emerging-markets countries.
Clearly, U.S. equities still grab the lion's share of large-cap portfolios. But there's more to the story. A fund's overall economic exposure can vary significantly from where its holdings are domiciled.
In this article, we'll look under the hood of two U.S. large-cap funds with successful, concentrated strategies to get a better picture of their economic exposures from a geographic standpoint. For contrast, we'll perform the same test on a concentrated foreign large-cap portfolio as well as a world-stock fund.
To estimate a fund's economic exposure, we take the percentage of each holding's reported revenues from the U.S. and overseas and adjust for its position size in the portfolio. These estimates are rough, as some firms group revenues from the U.S. under "North America" or "Americas," but the results are still interesting.
U.S. Funds' Foreign Exposure
The managers at Jensen JENSX, a U.S.-focused large-growth fund, generally invest in about 30 companies that have delivered returns on equity of at least 15% in each of the past 10 years. They have always owned firms headquartered in the U.S., officially giving it zero exposure to foreign-domiciled funds.
But shareholders' exposure is actually much broader. We estimate that 47% of this portfolio's underlying revenues come from outside the U.S. Consider, as examples, that the last annual reports for top holdings PepsiCo PEP, 3M MMM, and Emerson Electric EMR indicated that more than 50% of their revenues came from foreign countries. In fact, these companies' robust sales in emerging markets is a key reason why the Jensen managers own them.
Similarly, large-growth fund Marsico Focus MFOCX owns just one foreign-domiciled stock--Chinese internet firm Baidu--but around 44% of this portfolio's underlying revenues come from outside the U.S. Bigger positions in Apple AAPL and Wynn Resorts WYNN, which get more than half their sales abroad, help swing the fund's economic exposure that direction. But so does its stake in small-cap consumer electronics firm Harman International Industries HAR, which got an eye-popping 80% of revenues from overseas in its last fiscal year.
The fund's managers use a macroeconomic and bottom-up driven approach and are partial to firms that get a good chunk of their business from emerging-markets countries. This compact portfolio of around 30 holdings sometimes takes the direct route: It has had more than 10% of the portfolio in foreign-domiciled stocks at times. But whether it owns such firms or not, it's clear that it tends to be greatly exposed to foreign economies.
How "Foreign" Are These Overseas Funds?
The results were far less dramatic for the two concentrated foreign and world-stock funds in this test group. That's because they had some direct U.S. exposure to start with. Artisan International Value's ARTKX 13% stake in U.S. firms, including TE Connectivity TEL and Covidien COV, makes it stand out in the foreign large-blend category even at first glance. But the portfolio's overall exposure to the U.S. actually looks more like 29%, based on where its stocks have revenues. That figure is bolstered by U.K.-based Signet Jewelers SIG, which gets around 80% of its revenues from the U.S., as well as publishing firm Reed Elsevier REL, which derives more than half its business from the U.S. The managers' quest to find financially sound firms trading at steep discounts has often led them to small- and mid-cap names. And U.K.-based QinetiQ Group QQ., a technology supplier to the defense industry, has a market cap of less than $1 billion and gets about half its revenues from the U.S.
And the world-stock fund in this group, Oakmark Global Select I OAKWX, also has ample U.S. exposure. That's not surprising because two bottom-up stock-pickers put 20 of their highest-conviction ideas into this fund, and by mandate, the portfolio invests at least 40% of assets in U.S. stocks and at least 40% in stocks domiciled overseas. As of June 30, 2011, the fund's equity allocation by domicile stood at 44% U.S./52% non-U.S., roughly in line with its peer group.
But our economic exposure estimate shifts that breakdown to 38% U.S./57% non-U.S. Granted, that's not a huge difference. But the discrepancy stands in part to the fact that some of the fund's U.S.-domiciled holdings have hefty revenues from abroad. In particular, Intel INTC and Texas Instruments TXN reportedly earn 80% or more of their revenues abroad.
While the results for the U.S. funds were more dramatic than for the foreign large-cap and world-stock funds, they undermine the need for strict numerical asset-allocation targets for U.S. and foreign-equity exposure. Funds' constantly evolving economic and equity-market exposures reinforce that idea as well. That is, it's entirely possible that the typical U.S. fund will have less exposure to overseas firms 10 years from now.
These examples also underscore the importance of considering how your funds' economic exposures may overlap. Examining your core funds' strategies through shareholder letters and/or Morningstar analysis is a good start. While somewhat tedious, checking out where your funds' top holdings get most of their revenues can also provide helpful insight beyond the funds' overall equity-market exposures.
What you find may help you rethink how much you allocate to your favorite core U.S. and core foreign fund. And it may help you appreciate the foreign exposure, including ties to faster-growing emerging markets, that many funds have even without owning stocks there.