In literature, an author can add perspective and give balance to a novel by including points of view from multiple characters. In investing, an investment manager can add perspective and create balance in a portfolio by including stocks and other securities from multiple market sectors.

A sound investment strategy includes a well-diversified portfolio that balances risk and return over time. This diversity can be reflected in funds of stocks and other securities grouped by company size or industry. It can also be reflected in a portfolio’s geographical exposure, by including investments in emerging market funds or international stock funds.

Historically, a company’s country of domicile has had a significant influence on its stock returns because the majority of its production, sales and service took place in its home country. In the past two decades, however, a global business model has become the norm for most large- and mid-sized companies, and the world’s economies have become more integrated than ever before. As a result, evaluating stock funds and companies based solely on their country of domicile is becoming less effective, according to new research from The Capital Group.

In “The New Geography of Investing,” the authors suggest that investment managers should consider a company’s economic exposure, as well as its country of domicile. For example, a company might have suppliers, production lines, distributors and customers in multiple countries around the globe. Such variables, and exposure to multiple economies, are key considerations in the overall analysis.

“Globalization has had an enormous impact,” the authors wrote. “The economic world today is structured differently than it was just two decades ago. Free trade agreements, the European Union and its common currency, economic reforms and the rise of a middle class in Asia, Latin America and parts of Africa has allowed companies to compete for customers, labor, capital and natural resources on a global basis.”

Take automobiles, for example. Japanese automakers represent 40 percent of the world’s market capitalization for the industry, according to the MSCI SCWI Automobile Index as of December 31, 2012. Yet, less than 15 percent of global revenues for the automobile industry come from Japan. Alternately, developed Europe and emerging markets represent only about 20 percent and 15 percent of market capitalization for the industry, respectively; and each accounts for more than one quarter of global demand for automobiles. Thus, when evaluating the stock of an automaker headquartered in Japan, investment managers should consider economic factors in that country, as well as in Europe and emerging markets, and beyond.

“Looking at companies’ and portfolios’ economic exposure, using revenues as a proxy, provides better information than country of domicile,” the authors assert. “It will help

[investors] better understand the opportunities and risks embedded in portfolios and build investment programs aligned with participants’ objectives.”

Additionally, “investors focused solely on analysis based on country of domicile risk overlooking investments in companies that are well-positioned to benefit from potential growth opportunities in the fast-growing developing economies or, for that matter, firms that may be too exposed to certain economies, creating unintended imbalances in portfolios.”

For more in-depth analysis on global economic exposure of stocks and securities, read the following papers:

The New Geography of Investing. American Funds/The Capital Group, April 2013

Global Equity Allocation: Analysis of Issues Related to Geographic Allocation of Equities. MSCI, March 2012.