Geographical diversification is harder to come by, report says

As companies expand global operations and earn more revenue outside of their home countries, diversification is becoming more complicated for investors to measure, a report from Capital Group says.

“Correlations have become less differentiated between U.S. and non-U.S. equities, and this development is challenging previously held notions about constructing diversified portfolios, particularly in regards to exposure to international equities,” wrote Sunder Ramkumar, Capital Group’s senior vice-president for client analytics, and Michelle Black, solutions portfolio manager.

Investors used to be able to reduce risk by allocating portions of their portfolios regionally, but diversification doesn’t come as easily when correlations are more closely linked in a globalized world, the report said.

About 38% of sales for S&P 500 companies are generated outside the U.S., the report said, while roughly 69% of revenue for the 10 largest companies in the MSCI Europe index is derived outside Europe.

It’s now more important to invest in the right companies globally rather than to just get exposure to regional indexes, the authors wrote. While the S&P 500 outperformed the MSCI EAFE index by more than 5.8% annually over the last 10 years, more than half of the top-returning companies by sector over that period were based outside the U.S., the report found.

“This analysis illustrates how international equities can help improve the depth of investment opportunities for skilful managers, while also presenting a challenge for investment decisions that are made purely along rigid geographic lines,” the report said.

Rather than basing geographic exposure on the macro outlook, the authors recommended a more selective, bottom-up approach.

Staff

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