Why Economic Exposure Matters

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Summary

Investors with global portfolios need to know where the companies they invest in are domiciled.

It is equally important, however, for them to know where those companies earn their revenue.

Data from MSCI shows that the geographic distribution of companies’ revenues can have a significant impact on their stock prices.

That’s true particularly following events such as Brexit that impact financial markets and trade.

By Dimitris Melas, Global Head of Equity Research, MSCI

Investors with global portfolios need to know where the companies they invest in are domiciled. It is equally important, however, for them to know where those companies earn their revenue. Data from MSCI shows that the geographic distribution of companies' revenues can have a significant impact on their stock prices. That's true particularly following events such as Brexit that impact financial markets and trade.

A comparison of revenue by region for two British companies in the consumer discretionary sector illustrates the phenomenon. As the chart below shows, shares of Burberry, which earned roughly 10% of its revenues from the U.K. in the fiscal year ended March 31, gained more than 16% in the 22 days that followed the vote by the U.K. to leave the European Union. Shares of Barratt Developments, a U.K.-based homebuilder that derived all of its revenue domestically in the latest fiscal year, fell almost 30% over the same period. (The shares tumbled 40% in Brexit's immediate aftermath.)

A tale of two revenue streams (as of July 15)

Click to enlarge

Source: MSCI Research

Of course, the sensitivity of share prices within a sector to ups and downs in the economy matters, too. Those movements explained nearly half the performance of cyclical sectors such as industrials, consumer discretionary and information technology in the two weeks of trading that followed Brexit, relative to defensive sectors such as utilities and consumer staples.

Still, investors who aimed to understand the performance of equities in the aftermath of Brexit but who overlooked revenue exposure (which we refer to alternatively as economic exposure) would have missed more than a quarter of the reason why their shares moved as they did. Together, economic sensitivity and revenue exposure illuminated almost three-quarters of sector performance post-Brexit.

U.K. economic exposure by sector

Source: MSCI Research

Two factors explained three-quarters of post-Brexit performance

Click to enlarge

Source: MSCI Research

To take the analysis a step further, we estimate that each 10% of revenue above 30% of total revenue that a sector earned domestically (that is, within the U.K.) penalized the value of stocks in that sector by 2.5%. Conversely, each 10% of revenue above 70% of total revenue that a sector earned outside the U.K. rewarded the value of stocks in that sector by 2.5%.

The impact of revenue exposure on stock prices extends beyond the borders of Britain. Though Brexit reverberated primarily in the U.K., the shock also showed in the performance of equities in Europe and around the world (below table).

POST-BREXIT PERFORMANCE OF GLOBAL STOCKS IN IN THE U.K. AND BEYOND

Source: MSCI Research

Mapping the revenue of sectors worldwide based on exposure to Europe shows that those sectors with the greatest exposure to the Continent tended to underperform globally in the aftermath of the vote. As the performance of markets in the backwash of Brexit suggests, the ability of investors to analyze the geographic distribution of revenue in their portfolios may improve the process for constructing portfolios and measuring performance.

Further reading:

Economic Exposure in Global Investing

Why Economic Exposure Matters

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.