When the Berlin Wall fell, European leaders who wanted to acknowledge America’s role in the expansion of freedom snapped open some frosty cans of Coca-Cola rather than clink glasses of Champagne.
The choice of beverage made sense, since no other product is thought of as more American than Coke. What’s more, those classic cans would have been provided by Coca-Cola Enterprises (CCE), an NYSE-listed company that is a constituent of the S&P 500 Index. Not even the Dow Jones Industrial Average is as deeply rooted in America as the New York Stock Exchange, and the S&P 500 is nearly synonymous with U.S.-domiciled stocks.
And yet Atlanta-based Coca-Cola Enterprises, a fixture of U.S. portfolios, derives virtually all of its more than $20 billion in annual revenue from Europe. The product is American, its headquarters is American and its executives and shareholders are predominantly American, but the bottler’s business is to market soft drinks in Europe.
The case of Coca-Cola Enterprises points to a commonly overlooked flaw in an investment management business that thinks it is properly segregating assets by region, but is doing nothing of the sort. In an interview with AdvisorOne, Sarah Ketterer, CEO and portfolio manager of the boutique international value investment manager Causeway Capital Management, put it this way: “Where a company is listed may have little or nothing to do with where they generate their revenues and profits.” Ketterer used to head Hotchkis and Wiley’s international and global value team before founding Los Angeles-based Causeway 10 years ago.
The classic move that U.S. investors seeking global diversification make is to invest in the EAFE (Europe, Australasia, and Far East) Index, which is designed to invest in developed world markets except for the U.S. and Canada. Yet, “20% of EAFE’s revenues comes from North America,” Ketterer adds.
In an investment world in which due diligence managers are trained to chastise style-drifting portfolio managers, Ketterer argues that pledging allegiance to the EAFE Index is a form of misplaced loyalty. “What do clients want? Do they want to have a very fragmented set of indices where they think they can make these geographic distinctions or can they let us do it? Who is best suited to determine the geographic exposures? We’re the ones in the trenches,” she says.
And seen from the battlefield, the country of listing – as the Coca-Cola Enterprises example attests – is neither a reliable way to diversify client portfolios nor manage risk. Ketterer believes Causeway is the first investment management firm to map the revenues of companies in clients’ portfolios. She cited research that fast-growing emerging markets account for more than 10% of revenues from developed market stocks; but that exposure can reach as high as 40%-plus in Austrian stocks and close to 20% in the U.K., or be as miniscule as less than a percentage point in New Zealand and Ireland and a measly 6% in the United States.
Causeway does not have hard and fast rules targeting its sources of revenue, but “the knowledge is crucial,” says Ketterer. “Otherwise, you get blindsided.” While some might simplistically look at Causeway’s revenue map for opportunities to maximize ownership of, say, rapid growth in India through the safety of an established British company, Ketterer says the firm’s mapping strategy plays a crucial role in limiting clients’ risk through overconcentration in any one area. The revenue impact of Japan’s recent tsunami and nuclear crisis is an example of this danger. “Typically, the more geographic discretion we have, the better risk-adjusted performance we generate,” she says.
Professional investors would do well to think more critically about the formalistic yet artificial restrictions they impose on their investing. Managers of domestic stock portfolios are investing “wildly” overseas, she says; and unless they’re sticking to local utilities companies, the fungible nature of cross-border capital flows would make for a quite colorful diagram, with “arrows going back and forth and sideways.”
Coca-Cola’s teaching “the world to sing in perfect harmony,” as the 1970s-era commercial had it, presaged the emergence of globalization. Celebrating with Coke at the fall of the Berlin Wall may have marked its triumph. Now Causeway’s unique form of borderless investing through revenue mapping may be the first breach in the artificial barriers with which investment managers wall off their portfolios. Predicts Ketterer: “The EAFE Index is going the way of the buggy whip.”