What are sector and geographical weightings really telling us?, March 2022

When we are thinking about investing in a fund, one of the first things we will look at is the geographical and sector spread - the countries and the sectors in which it invests.

For example, if we look at a fund investing in US equities, is it invested mainly in the technology sector and is that something we are comfortable with? Or if it’s a global equity fund, is it truly global or does it mainly invest in developed markets?

There is no right or wrong – it’s what suits us as individuals best. But the information we find on fund fact sheets can sometimes be misleading. Because while a company may be listed in one country, its fortunes could be dependent on another.

Where do revenues come from?

The managers of Schroder Global Recovery demonstrated this to us recently. “A number of the holdings in our global fund, while listed in one country, have exposure in their business model elsewhere, so it’s important to also look at revenue derivation to capture the fully story,” they said.

“For example, by listing, Global Recovery has a 25% UK weight, but by revenues that drops to 13%. Similarly, our exposure to emerging markets is 9.4% by listing but 18.2% by revenues.
“A couple of examples can help bring this to life,” the managers said. “Anglo American has a dual listing (London and South Africa). We choose to purchase through the London listing because it has distinct governance, tax, operational and legal advantages. However, Anglo only derives 6% of its revenue through the UK due to the global nature of its business model.

“So, on a listing basis, Anglo is a c.1.5% UK position, but the reality is quite different. Or take UK listed banks HSBC and Standard Chartered: they derive only 15% and 6% of their revenues from the UK respectively.”

Stephen Yiu, manager of LF Blue Whale Growth fund, made the same point. “Although many of the companies we own are listed in the US (about 70% of our portfolio), almost all are large global companies generating revenues in Europe and Asia (often 40% or more), just like many companies listed on the FTSE 100 Index,” he said. “Taking this x-ray view of where revenues come from, we can see that our portfolio’s underlying exposure is very well diversified globally.”

Where UK companies get their revenues

It's a similar story for some UK funds. Schroder Income fund, for example, has more than 80% of its exposure by listing to UK listed companies, as per the UCITs rules, but regional exposure by revenues is far more diverse. Just 38% of revenues are from the UK. 17% are from emerging markets, 16.5% from North America, 14% from continental Europe, 4.5% from Asia Pacific ex Japan, 2.5% from Japan and the rest from frontier markets.
“It may be surprising for some clients that a UK fund only has 38% of revenue exposure to the UK while having 80% of its listing by weight here,” the managers said. “Looking at positioning exposure alone doesn’t capture the full story.”

And it’s not just the bigger companies that get their revenues from abroad. TB Amati UK Smaller Companies, has a surprisingly geographical feel to it. The managers of this fund go as far as showing the geographical distribution of the fund by revenue on the fund fact sheet. Currently it has 45.5% of revenues from the UK, 14.7% from Europe, 23.3% from North American and 16.5% from the rest of the world*.

Sector weightings can be misleading too

When it comes to sector or industry weightings, the story is similar.

“Most standard sector classifications are based on what a company sells,” said Stephen Yiu, manager of LF Blue Whale Growth. “Amazon operates an online retailer, so it’s often classified along with Walmart as a retailer. Adobe sells software so it’s classified with Microsoft as a tech business.

“While this represents a quick way of approximating a company’s sector exposure, it can be less helpful for understanding the true economic exposures behind a company’s performance,” he said.

“Take Adobe for instance. Adobe’s main customers are creative professionals in the media and entertainment space which exposes the company’s fortunes to video editing, photo editing, online marketing and online advertising. This ties its fate to the producers of content and the platforms through which they’re distributed. That’s why we classify Adobe under Media and Entertainment along with Disney, Netflix, Youtube and Facebook: it’s the demand for digital content that’s driving Adobe’s performance.”

Investing in the domestic market

Of course, there will always be funds that invest in exactly what you think they are investing in – like Alquity Indian Subcontinent.

Manager Mike Sell told us: “India benefits from some of the most significant and long-lasting trends of any country in Emerging Markets, such as a huge and growing young population, the shift from the informal to formal economy and low but rising levels of urbanisation.

“This means that India’s growth trajectory is largely insulated from global economic and geopolitical events, as exports are only approximately 18% of GDP compared to 36% in Korea, 51% in Thailand or 105% in Vietnam.

“Therefore, investors’ should naturally focus on Indian companies that benefit from these structural themes as they are largely unparalleled elsewhere globally.
“Of course, there are pockets of external focus – such as software services (for example, Infosys which is world-class), and Modi’s ‘Made in India’ programme will increasingly provide opportunities in the manufacturing sector (such as Dixons Technology). Nevertheless, the Alquity India story is very much a domestically driven one.”

*As at 31 January 2022

Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. The views expressed are those of the author and fund managers and do not constitute financial advice.

Published on 09/03/2022