U.S. companies account for about half of the total global market capitalization and a far lower percentage of total global revenue, according to independent reports from Strategic Insight (an Asset International company) and Portfolio Evaluations, Inc. (PEI)—yet it’s common for U.S. investors to maintain 80% or more of their equity allocations in domestic stock. Both firms recently published research warning that a greater global focus is required to truly diversify portfolio exposures and broaden potential sources of investment returns.

Achieving proper diversification across U.S. and global markets is especially important for workplace retirement savers, the research contends. Workplace investors are easily spooked by volatility—leading to poor buy-high-sell-low behaviors and ill-fated attempts to time the market. This puts pressure on plan sponsors and advisers to tailor investment menus to achieve a global perspective that can keep volatility down as much as possible. And as Strategic Insight’s report explains, increasing regulatory acceptance of non-U.S. investments in individual portfolios indicates that “the time has come to deepen the discussion on geographic classifications.”

Investors succumb to the home country bias for a variety of reasons, researchers from Strategic Insight (SI) and PEI contend. Investors often have a greater feeling of comfort and familiarity with companies listed in their own country. PEI’s report, in particular, suggests investors feel more in control of a localized portfolio because they believe proximity to home provides them with a relative informational advantage. The PEI report also points to investors’ fears—in most cases unfounded, thanks to digital communications and recordkeeping technology—that capital invested globally will be less liquid or harder to recall than domestic assets.

Even as these fears continue to hold back many investors, SI suggests global diversification is more necessary than ever to achieve top tier investment returns. Although the emerging and developing markets should experience a slowdown from current growth trends, SI predicts their growth rates will remain both positive and stronger than that of the U.S. market for some time to come. PEI researchers predict that, by 2025, emerging markets will capture about half of global GDP, with China being the largest economy in the world.

To benefit from these long-term macroeconomic trends, individual portfolio exposures must be shifted to include more (and more sensibly weighted) geographies. Researchers at PEI suggest asset-allocation strategies focused on global growth opportunities to add alpha are best positioned to outperform in the years ahead. SI researchers say another way to steer global investments is to pay attention not just to the location of a company’s corporate headquarters, but also to where the company’s revenues are coming from.

Today many individual investors fail to consider that even companies headquartered in the U.S. or developed European markets generate significant portions of their revenues outside of their country of domicile. This leads many investors to maintain an asset allocation based on a traditional boundaries approach, PEI says, which may misrepresent risks within the overall portfolio.

Both SI and PEI warn investors that fundamental research should start taking a greater focus on different company metrics beyond location and capitalization—including revenue, profits and assets. Questions to ask include: “Where does a company generate its revenue and profits? What is the geographical breakdown of a company’s assets and activities? These factors are becoming increasingly important because a large number of companies are global and driven by performance across multiple markets, PEI says.

All of this makes the current case for emerging market investments particularly compelling, researchers from both firms explain. As the PEI report suggests, “It is notable that about half of the revenues of companies in the MSCI All Country World Index are now generated outside of the U.S. and developed Europe. Those revenues are largely generated in emerging markets, despite those markets only representing 11% of the world’s investment opportunity based on market cap.”

The implication is that, with decreasing importance of sovereign boundaries, global investing has changed over the last decade, leading to increased correlations among stocks. As a result, PEI suggests, due diligence in selecting managers that focus on the best in class companies—regardless of where they are headquartered—has become increasingly important.

The prevailing view among asset managers PEI has met with, the research suggests, is that global investing should include broadly developed markets, some emerging markets, and some foreign small cap stocks. Furthermore, global investing is not only about equities, but should also include global fixed income, such as emerging market debt and global high-yield debt—as their real yields are currently above those of the Barclay’s U.S. Aggregate Bond Index. Similar to stocks, PEI says, the composition of the global bond market has shifted and is currently 35% U.S. and 65% rest-of-world.

The PEI report is available here. To obtain a copy of the SI report, contact DCResearch@sionline.com.