Foreign Revenue: A New World of Risk Exposures

Abstract

The predominant approach to classify securities geographically today is based on domicile, which is typically binary, and on the legal home of a company. This article explores whether foreign revenue exposure in addition to domicile should be considered when assessing the risk of an investment. The findings suggest that foreign revenue exposure explains a meaningful level of variation in excess returns and excess risks among domestic mutual funds at a level that is similar to more traditional domicile metrics. Investments focused on revenue exposure also appear to capture different economic risks that could make them attractive to certain investors. <b>TOPICS:</b>Emerging, mutual funds/passive investing/indexing, performance measurement <b>Key Findings</b> ▪ Domicile is the most common metric used to determine the geographic location, and risk, of investments today. This article explores foreign revenue exposure, which unlike domicile is not binary and allows for a more complex consideration of risk exposures. ▪ Evidence suggests that foreign revenue exposure captures different economic risks than domicile and that it explains a meaningful level of variation in excess returns and excess risks among domestic equity mutual funds across a variety of styles and countries. ▪ As global economies become increasingly interconnected, legacy metrics such as a domicile are likely to become less relevant in describing the risks of a given strategy. Therefore, additional metrics, such as foreign revenue exposure, should be considered when developing portfolios.