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Size of Markets and Trading Volumes

Crops

The previous article in the series gave an overview of the various asset classes, and typical risk/return relationships. In this second column, Les Nemethy and Sergey Glekov compare the liquidity and trading volumes of these asset classes.

Why is this important for investors? A basic principle of asset allocation is that you need to have sufficient liquidity, to look after your personal, family and business needs, and possibly take advantage of opportunities that might present themselves (e.g. during a recession). If the asset class you are in is traded in a small market or, for whatever reasons, particularly illiquid, you might need to ride out a recession before you can dispose of your asset.

Shares in most private corporations fall into this particularly illiquid category. Few business owners realize that in times of severe recession, EBITDA (Earnings before Interest, Tax and Depreciation) might go down by 50%, and multiples might go down by 50%, meaning that your share price might go down by 50%, meaning some shares in private corporations might only be worth a quarter of what they were worth at the previous market peak.

Not to mention that, with all the difficulties related to due diligence, and investor appetite might just disappear altogether. So a diverse portfolio is important. Let’s compare some of the alternative asset classes:

Real estate is the world’s most important asset class, with an estimated total value of USD 217 trillion at the end of 2016, according to Savills in “Around the World in Dollars and Cents 2016”. This figure includes only high quality retail property, offices, industrial, hotels, residential, other commercial uses, and agricultural land

By comparison, the size of the global bond market as at the end of 2016 was USD 92.2 tln and global equity market capitalization was USD 70.1 tln. In other words, the value of real estate is more than publicly traded stocks and bonds put together.

The most important component of global real estate value is residential property. According to a Savills report: “There are approximately 2.5 billion households on the planet and those in developed economies occupy housing at much higher price points than those in less developed economies. Savills estimate that the median value of the dwellings occupied by all households is USD 43,000.”

As at the end of 2018, capitalization of global bond markets outstanding topped USD 100 tln, while global equity markets surpassed USD 85 trillion.

U.S. Dominates

The United States dominates both global bond and equity markets; however, the role of emerging countries has risen dramatically over the past decade: in 2008 emerging markets accounted for only 5% of the global bond market and 20% of the global equity market capitalization, rising to 20% and 27% respectively in 2017, according to the SIFMA Fact Book 2018.

Trading volumes (daily average calculated over the course of a year) is an often-used indicator of liquidity. For example, according to the Savills report, average annual real estate trading volumes (excluding Chinese land) were USD 683 billion between 2008 and 2015, not that much greater than average daily trading volumes of U.S. treasuries, namely USD 505 bln.

Overall, average daily trading volumes of U.S. treasuries significantly outperforms other categories of government bonds, and even combined trading volumes of NASDAQ- and NYSE-listed stocks.  

Just to put a few alternative investment markets into perspective: according to the Bank of International Settlements’ SIFMA Fact Book 2018, the total value of commodity contracts traded in 2017 was USD 5.7 tln; that same year, the annual turnover of the art market turnover was estimated at USD 63.7 bln, according to Art Basel and UPS in their “Art Market 2018” report, which include auction sales, galleries and dealer sales.

Once again, the main take-home message here is the need for diversification, not only in returns, but also as related to liquidity. For example, owning shares in specific private corporations or real estate might offer very high returns, but these are also considered to be very illiquid investments. You need to balance this with liquid investments, including a certain amount of cash and near cash type assets.

Choosing your asset classes is perhaps the most important decision you will make in designing your portfolio, and your financial well-being.

Disclaimer: This article is intended for informational purposes only, and should not be relied upon for investment advice. It is important to do your own investigation and analysis before making any investments based on your own personal circumstances.

Les Nemethy is CEO of Euro-Phoenix (www.europhoenix.com), a Central European corporate finance firm, author of Business Exit Planning (www.businessexitplanningbook.com) and a former president of the American Chamber of Commerce in Hungary.

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