Global equity asset management is typically structured around country asset allocation, where market capitalization index weightings provide a reference set of country allocations. This is supported by the observation that country specific elements are a major influence on stock-price behavior. Conversely, if a corporation is considered as a portfolio of international activities, its stock price should be influenced by international factors related to the geographical breakdown of its activities rather than the location of its headquarters or where its stock is listed and traded.
As companies expand globally, a greater proportion of revenue arises from sources other than the country of incorporation or primary listing. Consequently, one alternative way to group companies is by examining geographical sources of revenue. This approach is motivated by the observation that the performance of domestic and globally focused companies is likely to be influenced by different macro-economic factors. Global companies, diversified across geographic regions, are less likely to be influenced by localized economic conditions.
We examine the impact of unanticipated changes in exchange rates on firm value as an appreciation of the home currency may adversely affect the competitiveness of global firms. Domestic firms are also affected by exchange rate fluctuations if for example their suppliers are exposed to international trade, or they have foreign operations and through effects on overseas competitors.
The objective of this paper is to evaluate criteria for creating homogenous groups of global and domestic companies. This may help market participants gain a deeper understanding of the effect of macro-economic events and exchange rate changes on firms.
We use the proportion of overseas sales to total sales, the global sales ratio (GSR), to assess a company’s level of domestic and global activity. We illustrate that a homogeneous group of companies with similar exchange rate exposure can be formed using the GSR, irrespective of size or industry differences. We show that the UK companies categorized as global using the GSR, including smaller and FTSE 250 companies, exhibit negative exchange rate exposure on average and benefit from a depreciation of Sterling. Conversely, Domestic companies exhibit positive exchange rate exposure on average. Our results indicate that the GSR provides a cleaner separation than market capitalization in forming global and domestic proxies for the UK. We also examine the effectiveness of the GSR in separating the Russell 1000® and FTSE Japan constituents into domestic and global categories.
Finally, we highlight subtle differences between the GSR and exchange rate exposure. The GSR is based on accounting data and therefore observable. Exchange rate exposure results from a regression analysis and is sensitive to the specification of the regression. Furthermore, a firm's hedging policy will affect exchange rate exposure estimates and hence the global nature of the firm. We conclude that the GSR is a preferred measure for forming distinct groups of global and domestic stocks.
Companies are required to disclose geographic revenue breakdowns under both ASC280 (US GAAP) and IFRS. For example, IFRS8 requires entity-wide disclosures of geographic revenues from external customers. Information by geographic area is required for an entity’s country of domicile and for foreign countries, if material. Drawing on this data, we calculate the global sales ratio (GSR) as the proportion of total sales arising overseas. By definition, the domestic sales ratio (DSR) is one minus the GSR.
Investment trusts in the UK are listed companies whose assets consist of a portfolio of shares and other securities. We exclude Investment Trusts from our UK analysis since investment mandates may be global and therefore not reflect the geographic breakdown of UK listed stocks.
We examine the geographical revenue sources of the constituents of various country indexes. The index level GSR is the weighted average GSR. Figure 1 shows the average GSR between 2007 and 2015, for the FTSE 100, the FTSE 250 ex Investment Trusts, FTSE Japan and Russell 1000 indexes. We observe a significant difference in average levels of overseas exposure across regions. The FTSE Japan and Russell 1000 indexes are on average largely domestic, deriving less than 40% of their revenues from abroad. The GSR of the UK market is more nuanced; The FTSE 250 ex Investment Trusts is more domestic compared to the FTSE 100 Index, deriving 51% of its revenues from outside the UK compared to 76% for the FTSE 100.
Figure 1. Average Global Sales Ratio (%) (2007 – 2015)
Figure 1: Average Global Sales Ratio, September 2007 to September 2015. Source: FTSE Russell, data as of April 7, 2017.
In the remainder of this paper we show that the performance of companies with similar GSR are driven by similar macro-economic factors and in the case of the UK, the GSR is a cleaner way to separate global from domestic companies than market capitalization. Our results show that a small proportion of FTSE 100 firms may be classified as domestic and a larger proportion of FTSE 250 stocks display global characteristics.
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