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(Pictured: Andy Budden)

Investing in broad market indices such as the S&P/ASX 200 may inadvertently give rise to unexpected geographic exposures, according to analysis by Capital Group, one of the world’s largest active fund managers.

While investors have long known that many Australian companies are active in other countries, they may be surprised to learn that approximately 43 per cent of revenues by companies represented in the S&P/ASX 200 Index are from outside Australia.

This trend is not exclusive to Australia and is being mirrored in other developed markets around the world. In the UK for example, 77 per cent of the revenues generated by companies represented in the FTSE 100 are derived from outside the UK. In the US, the companies in the S&P 500 Index derive 40 per cent of their revenues outside of the US.

At a global level, the MSCI All Country World Index is the broadest global equity index comprising 2,500 companies. Emerging markets represent only 11 per cent of the MSCI ACWI by market capitalisation, but 34 per cent by economic exposure, or more than a third of all global demand. At the same time the US accounts for 49 per cent of the index, but only 28 per cent of demand.

At a sector level, it is a similar story for Australia’s top 200 companies. For S&P/ASX 200 Materials companies for example, their economic exposure in terms of percentage of revenues derived from outside Australia is more than 88 per cent.

For energy companies, their economic exposure to revenues outside Australia is 63 per cent. Australian healthcare companies in the S&P/ASX 200 derive 83 per cent of their revenues from outside Australia, with almost 32 per cent derived from the US and about 25 per cent from developed Europe.

Capital’s analysis notes that the decades‐old practice of using a company’s locale as a good proxy for where it does business, and thus its prospects, is increasingly out of step with today’s global economy.

Although the investment industry continues to use geography ‐ where a company is headquartered or domiciled ‐ for asset allocation and portfolio construction, the study points out that in today’s world where a company is domiciled tells investors little about its potential.

“Australian investors are well attuned to globalization but they may need to change the way they view – and use – traditional stock market indices,” says Andy Budden, an investment specialist at Capital Group.

“Our analysts’ approach is to look at where companies generate their revenues as a way of assessing their future performance, and share price growth prospects. We call this ‘The New Geography of Investing’.”

“This hasn’t been possible in the past because companies do not tend to report revenues in enough detail – but it is starting to change,”

“What we are seeing around the world now is that enough companies are reporting revenues by geography. This is giving us a much more accurate picture of not only what is driving their revenues, but where they’re coming from.”