Morningstar Advisor - February/March 2010 - 40

Spotlight Crafting a Global Investing Strategy By Marta Norton There’s more to the world than equities. Fixed income and real estate are important components of a global portfolio. The case for geographic portfolio diversification has been well established for years. But the emergence of China and other developing markets as major players in the global economy has underscored the strategic importance of foreign investments to a portfolio. Where clients might once have considered such areas to be “nice-to-have” components of a portfolio, they’re now clamoring for such exposure. The question is whether investors are thinking expansively enough in allocating capital to foreign securities. For example, Morningstar mutual fund-flow data shows that U.S. investors have flooded international equity funds with assets but largely ignored other asset classes that also provide global exposure, such as world-bond funds. This suggests that investors tend to have a narrow definition of “foreign.” When choosing investments for clients of Morningstar Investment Services, we try to look beyond foreign stocks into areas such as global fixed income and real estate. Moreover, when we evaluate the domesticequity portion of the portfolios we manage, we take a close look at our fund managers’ underlying holdings to determine the degree to which those stocks are tied to overseas sales and operations. In that way, we can make a more comprehensive assessment of the portfolio’s true global economic exposure and construct the portfolio accordingly. We’ve found that putting this approach into practice requires a change in mindset—we’ve had to break ingrained habits that have put “homecountry” investments front and center in a portfolio. Further, we’ve adapted our fund-selection criteria as we have gained a full understanding of the opportunities and risks that a truly global perspective entails. In the following sections, we lay out our approach to global investing and describe how we’ve applied it to the nuances of three asset classes—stocks, bonds, and real estate. Equity a large-cap fund that we use in many of the mutual fund strategies that we manage, is dotted with the stocks of global multinationals. As of Sept. 30, 2009, three of the fund’s top-five holdings derived at least half of their revenue outside the United States in 2008. Beyond considering a stock portfolio’s “hidden” foreign exposure, we think it also pays to regard global equity investing as a distinct strategy unto itself. Often, we find that investors compartmentalize foreign-stock investing, putting domestic managers at center stage and relegating foreign stocks to a largely supporting role. By contrast, we tend to gravitate toward strategies that give their managers full run of the U.S. and foreign stock markets and, thus, the ability to flow to their “best ideas.” In that way, we’re less prone to habit or “home-bias” and can make better use of our managers’ perspective on the relative attractiveness of stocks the world over. Of course, a global-stock investing mandate significantly ups the ante—though many mutual fund firms have moved from having separate U.S. and international research arms to global sector teams, successful global investing depends on discerning instincts at least as much as plentiful resources. Even the best domestic-stock managers might struggle if they expanded their gazes to foreign markets— and vice versa for foreign-stock managers. So, When it comes to the international equity markets, we’ve found that it’s more about individual companies than countries. That’s because where a company is domiciled often has little to do with where its operations are located or where it generates sales. In fact, Standard & Poor’s reports that S&P 500 companies derived 47.9% of their sales outside the United States in 2008, which was up from 45.8% in 2007. For that reason, we factor our domestic large-cap fund managers’ foreign exposure— which they gain by owning franchises that do extensive business abroad—into portfolio construction. For example, the portfolio of MainStay ICAP Select Equity ICSOX, 40 Morningstar Advisor February/March 2010

Morningstar Advisor - February/March 2010

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