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Developing world worth a look

PSI |  17 November 2013  |  Portfolio



One of the biggest elements of risk minimisation for SMSF investors is geographical diversification: investing in different countries or regions. It is a way to reduce the risk of being exposed to only one economy, and for the most part SMSF investors do not take advantage of it. One way is to buy indexes, which reduces individual company risk. Another way is to focus on local stocks that have international exposures.

Many Australian companies have offshore operations, which provides some diversification options. Companies like Amcor, Brambles, Orica and the mining giants have global operations. But the AFR is today quoting Capital Group, the $1.5 trillion US-based manager, which co-created the widely followed Morgan Stanley Capital International index (MSCI) in 1970, saying that the information provided to investors is not good.

About 43 per cent of revenues generated by Australian companies are derived internationally. But there is not much in the Asian region:

“Investors in Australia have had the view that they don’t need to think about emerging markets because they are already getting it. But they wouldn’t necessarily get the emerging market exposures they desire [from investing in the local index],” Capital’s Singapore-based portfolio manager Andy Budden told The Australian Financial Review.

The findings formed part of a global study conducted by the fund manager that revealed sharemarket investors and the indexes they dogmatically follow have failed to keep pace with the rise of the multi-national corporation, leading local indexes to misrepresent the geographic exposures of those companies.

“Basing investment decisions on where a company’s post is delivered is certainly not the best approach,” ­Capital Group’s Australian head Paul Hennessy said. The time had come, Capital’s analysts say, to rebase investment decisions on where a company earned its revenues not where it was headquartered. “Our sense is this is just reaching a tipping-point where if investors don’t start to think about it carefully they will end up with outcomes they weren’t expecting,” said Mr Budden.

Globalisation has transformed the world's largest corporations. But the same has not quite happened in the capital markets. There is an imbalance between the value of shares and revenues. US listed companies account for about half of the world's share value yet contributes only 28 per cent of the revenues of globally listed firms. Emerging markets account for just 11 per cent of world share value yet 34 per cent of the revenues of companies in the index:

“The reality is that the old geography is really starting to show its age. It doesn’t lead to a portfolio incorrectly invested but one where investors don’t understand what it’s really about,” Mr Budden said.

Mr Budden says there are measurable signs that companies had become borderless such as a decline in tariffs from 26 per cent to 8 per cent. Also exports as a percentage of global GDP had more than doubled from 15 per cent to 33 per cent.

The imbalance is to a large extent a reflection of the different financial systems of the developed and developing world. Buying shares in developing countries carries much greater risks and so the vauations tend to be lower. But buying an index removes the individual company risk and with the $A high, there may be a case for putting some funds in emerging market indexes, given the mismatch between revenues and share value.
Another way is to look at the exposures of Australian companies wit global operations. But their value will also depend on the business they are in. Brambles, for instance, has global operations, but assessing its value will largely dpeend on the fate of the pallett business.
Based on the graph below, the IT sector possible offers the best international exposure, although much of that will be in the developed world.



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