Christine Benz: Hi, I'm Christine Benz for Morningstar.com. Your mutual fund may be more globally oriented than it first appears. Joining me to discuss some new research on that topic are two Morningstar analysts, Robby Greengold and Alec Lucas.
Gentlemen, thank you so much for being here.
Robby Greengold: Thanks for having me.
Alec Lucas: Thanks for having us.
Benz: Robby, let's start with you because you have been looking at this issue of country of domicile which is historically how we have thought about labeling mutual funds as either U.S. or foreign stock. You have looked at some different ways of perhaps determining how global portfolios actually are. Let's talk about that. Let's talk about how a fund that we might have classified as U.S. stock might actually look pretty global when you unpack where it's actually sourcing its revenues.
Greengold: That's right. American companies today, iconic American companies, have become increasingly global in their sales and operations. McDonald's, for example, the fast food chain based in Illinois, McDonald's derives only about a third of its total sales from the U.S. Johnson & Johnson, another American brand, it sells just as much abroad as it does at home. And the tech giants, American tech giants like Apple, Facebook, Google--they all have significant exposure to international markets.
This is a story about portfolio diversification. Traditionally, investors have sought to diversify their portfolios by looking at where is this company based. If I'm looking to own a basket of stocks, I'm going to look to own a basket of stocks domiciled in country A instead of country B. Given the perhaps diminishing relevance of country of domicile, another critical tool that investors should be aware of is the ability to look at what their underlying stock exposures are to the end markets that are deriving the revenues.
Benz: Alec, it's not that we are going to take away country of domicile as a tool that investors can use to sort of look at how global their portfolios are or are not. But we are actually adding this revenue lens as maybe an additional way to look at how global a portfolio is.
Lucas: As companies have become more multinational, they have begun disclosing where their revenue comes from, and that's become an important lens and one that's helpful and additive. At the same time, domicile is important, too. There are some assumptions in the way that we come up with revenue exposure. If it's a certain region, we will weight it by GDP. There are some assumptions built in. There's limitations to what we do. We think the way that we are doing this is consistent and fair and very helpful, but there are limitations. It's important to point out there's limitations to domicile as well. Some companies' domicile isn't necessarily an accurate depiction of the complexity of its operations.
Broadcom is a good example. It's a company that has its origins as a division of Hewlett-Packard in the 1960s. It's a company that's been built up through multiple acquisitions. Its ticker is AVGO, which is a heritage to the company's former name, which is Avago Technologies. They acquired Broadcom, took its name in the 2015-2016 period and recently in April shifted their headquarters from Singapore to the U.S. This is a company that gets 50% of its revenue from China and about little less than 10% from the U.S. and yet, it's a U.S.-based company. This is a good example of how there's limitation to domicile.
There's other examples. Ferguson supplies building and plumbing supplies. It's based in London, but it gets most of its revenue from the U.S. We feel like for companies like that you really want to focus on revenue. But domicile still matters in terms of investor protection and there's certain countries where the laws are not up to par with developed nations and you want to be cognizant if a company is headquartered there.
Benz: Good point. We are going to be providing this data in the products later in the year where people will actually be able to look at their mutual fund portfolios with this revenue lens. Let's give an example though right now of a fund that might appear to be a domestic fund, we've got it classed as a domestic fund, but one that actually holds companies that are quite international in terms of their revenue exposures.
Greengold: Well, one good example would be Harbor Capital Appreciation. This is a domestic fund. We rate it Gold. Looking at the portfolio, you see a lot of U.S. exposure; 90% of the portfolio appears to be domiciled in U.S. companies. Yet, when you look at that same portfolio through the lens of revenue exposure, this is a fund that generates just about half of its aggregate revenues from foreign markets.
Investors in the foreign stock category might also be surprised at the U.S. exposure that they have. For example, MFS International. It's a Silver-rated fund that appears to own not a single U.S.-based company, and that's true. But still this is a fund that generates a quarter of its aggregate sales from the U.S. market.
Benz: There are examples on both sides. You've got U.S. funds with heavy foreign revenues, and you've got foreign funds with heavy U.S. revenues?
Greengold: That's right. It's important for investors to realize because if they are targeting an international market in their mixing and matching of fund managers, then it's important that they realize that perhaps that international stock fund is giving them exposure to the market that they are specifically trying to diversify from.
Benz: Right. And it could also be an explainer at various points in time about why your funds are performing as they are. If your U.S. fund isn't performing that well in a U.S. market that's really strong, it may be that some of its holdings have heavy overseas exposure and that's what's driving the results.
Greengold: That's right.
Benz: Another thing I want to talk about is value versus growth. When you looked at the revenue exposure of U.S. value funds versus U.S. growth funds, did you find any patterns there in terms of their international exposure?
Greengold: Yeah. We found that large-growth funds typically appear to invest mostly heavily in overseas markets. The other side of that is small value funds which appear to cling most closely to their domestic market. There are a few key reasons for large-growth funds to prefer foreign markets. One reason is that, well, they focus on large companies and naturally a large multinational is going to have a grander and global scale of operations. Growth funds are looking for where the highest growth markets are going to be, and they are looking to invest in those companies that are going to benefit from that underlying economic growth. Often, that's not in the U.S.
Also, large-growth funds are typically benchmarked against the Russell 1000 Growth Index; a significant share of that index is comprised of tech companies. Information technology lends itself more easily to foreign markets because of the nature of their business model. Many of these companies, their intellectual property is at the core of their business model, and their intangible goods can be more easily sold to international markets. Another reason why value investors might be investing more domestically is because financials are such a large part of the Russell 1000 Value. Banks and other financial institutions don't often do business in overseas markets.
Benz: Alec, when investors do get their hands on these data and I know they are coming later this year, a question is, if I see a fund that I had heretofore thought of is kind of a domestically oriented fund, is it a red flag or a reason for concern or a reason to expect higher volatility, if through this revenue lens it looks like it's actually a pretty global portfolio?
Lucas: I think it's really important to understand what you own and what's driving the exposure. Robby mentioned Harbor Capital Appreciation. It had big stakes at the end of the year, last year, in Tencent and Alibaba. Wwhat's interesting about those companies in contrast to a lot of companies domiciled overseas that might be multinationals and have pretty broad revenue exposures, in both of those cases the vast majority of their revenue is from China itself. So, in that case, that's a domestic fund where there is a lot of country-specific risk. I think that it's quite helpful to add this revenue lens and to drill down to individual holdings which we will eventually be able to do. Robby mentioned financials. A lot of times financials in the U.S., a lot of their revenue is from the U.S. There are exceptions. Citigroup has a pretty significant percentage of its revenue outside the U.S. If your fund has a big holding in Citigroup as opposed to JPMorgan Chase, then you should know and you will be able to verify that you've got more overseas revenue exposure than you otherwise might have.
Benz: Really interesting data. I'm excited to see it. I know it's something we've been talking about for a long time. Thank you both for being here to discuss it with us.
Greengold: Thank you.
Lucas: Thanks for having us.
Benz: Thanks for watching. I'm Christine Benz for Morningstar.com.