World Stock and Bond Markets and Portfolio Diversity, 2010

How diversified is your investment portfolio? How does it compare to the diversity of the global capital markets? In order to facilitate this comparison, the Asset Allocation Advisor updated the following table for the values of the worlds stock and bond markets, first published in November 2009.1 The most striking observation one can make from the table is the sheer size of the markets. The worlds stock and bond markets in aggregate have a market value in U.S. dollar terms of more than $140 trillion, or more than two times the value of the worlds economic output, estimated at approximately $62 trillion in 20102. It is also interesting to note that the world bond market exceeds the world stock market in size by a factor of nearly 2 to 1. U.S. equities account for just less than one-third of the global stock market value despite the fact that U.S. economic output accounts for less than one-fourth of global output. U.S. bonds account for a somewhat larger portion of the global bond market at just over 35%. Values of the World Stock and Bond Markets, 2010
In equivalent U.S. dollars, numbers in billions Bonds4 Stocks3 U.S. 16,690 32.2% 32,081 35.1% 5 euro zone 5,951 11.5% 24,869 27.2% China (including Hong Kong, excluding Taiwan) 6,660 12.9% 3,023 3.3% Japan 3,542 6.8% 12,872 14.1% UK6 2,830 5.5% 4,744 5.2% Canada 2,002 3.9% 1,957 2.1% India 1,540 3.0% 699 0.8% Brazil 1,447 2.8% 1,353 1.5% Australia 1,309 2.5% 1,432 1.6% Switzerland 1,122 2.2% 732 0.8% Norway, Sweden, Denmark, Iceland 1,183 2.3% 1,905 2.1% South Korea 992 1.9% 1,189 1.3% South Africa 821 1.6% 189 0.2% Taiwan 723 1.4% 10 0.0% Singapore 611 1.2% 115 0.1% Russia 816 1.6% 146 0.2% Mexico 431 0.8% 513 0.6% Malaysia 386 0.7% 246 0.3% other 2,697 5.2% 3,224 3.5% Total 51,753 100.0% 91,300 100.0% Percent of total stocks & bonds 36.2% 63.8% Total stock & bond markets 143,052

Investors have no reason to match the diversity of the global capital markets in their portfolios just for diversitys sake. Allocation decisions should be made on the basis of which capital market instruments will contribute most efficiently to total portfolio return and risk and not on the

Copyright, the Asset Allocation Advisor. All rights reserved. December 2010. www.aametrics.com

basis of trying to replicate relative market values. Nevertheless, the size and diversity of the worlds stock and bond markets is an indication that opportunities for more efficient portfolio diversification may be available to those whose investment options span the global markets. Investors who limit themselves to a domestic market or to a limited segment of the global market are likely losing out on opportunities for better return/risk performance. We also provide the following table on the components of the U.S. bond market, data courtesy of the Securities Industry and Financial Markets Association.7 U.S. Bond Market Debt Outstanding8
As of 30 September 2010, dollars in billions U.S. Treasury (marketable securities out of a 8,864 2,587 2,869 7,442 2,885 8,893 2,204 $35,748
total debt of $13.8 trillion, $9.3 of which is public)

Agencies of the U.S. State & Municipal Corporate Money Market Mortgage-backed Asset-backed Total

The largest segments of the U.S. bond market, in terms of outstanding and marketable debt, are the mortgage-backed and U.S. Treasury markets. These two segments along with the Japanese sovereign debt market are larger than any of the worlds stock markets, except the U.S. stock market. Compared to the November 2009 report, U.S. Treasury bonds outstanding have increased from 6,927.8 billion to 8,864.3 billion. This increase can be attributed to the larger deficits caused by the recession and stimulus spending in the U.S. Just as investors need not necessarily mimic the global diversification of the equity and bond markets in their portfolios, they also need not mimic the diversification of the U.S. bond market in the domestic bond portion of their portfolios. Once again, the critical question is which asset classes will contribute most efficiently to the return and risk characteristics of their portfolios. This is an issue to be decided on the basis of expected returns, risks, and correlations, not on relative asset class market values. Although investors may not include all of the global stock and bond or U.S. bond asset classes in their portfolios, all of these asset classes (and others such as real estate and commodities, to name just two) should be under consideration. They should be in the universe of possible investments, and the asset allocation/portfolio management process should evaluate the contributions which they could potentially make to portfolio return and risk performance. Optimal portfolios need a broad range of investment options. A limited range is imprudent and may result in lower future returns and/or higher return volatility. Albert J. Brenner, CFA With assistance from John Murray II December 20, 2009

Copyright, the Asset Allocation Advisor. All rights reserved. December 2010. www.aametrics.com

Careful readers will note that stock market values are based on market capitalization while bond market values are based on debt outstanding. Values for the stock markets, therefore, are true market values, whereas values for the bond markets are essentially book values and do not reflect the market values of the outstanding bonds. Since global interest rates generally are near to historic low levels, it would not be unreasonable to estimate that the market value of global debt is at least equal to, if not greater than, the book value of the debt. Readers should also note that stock market values are generally as of 30 November 2010 while bond values are as of 30 June or 30 September 2010, all being the most recent data available at the level of detail required for this compilationsee notes 3 and 4.
2

International Monetary Fund estimate

Stock market capitalization data is as of 30 November 2010 from the World Federation of Exchanges except for Italy. Data for the Italian stock market is from the Borsa Italiana (see endnote 5). Bond market data is the most current available data from the Bank for International Settlements. Domestic debt outstanding ($63.7 trillion out of $91.3 trillion total) is reported as of 30 June 2010 while international debt outstanding ($27.6 trillion out of $91.3 trillion total) is reported as of 30 September 2010.
5 4

The calculation for market capitalization for the Borsa Italiana is derived from data on their website (http://www.borsaitaliana.it/homepage/homepage.htm).

The Borsa Italiana was purchased by the London Stock Exchange Group (LSE) and the calculation for the UK market capitalization is the LSE market capitalization minus the Borsa Italiana capitalization data. Domestic bond market data provided by the Securities Industry and Financial Markets Association (SIFMA) is not directly comparable to the data provided by The Bank for International Settlements (BIS). BIS reports outstanding debt for nations by government, financial institutions, and corporate issuers for both domestic and international issues. The total U.S. debt outstanding as of 30 June 2010 was $31.8 trillion according to BIS, compared to $35.4 trillion at 30 June 2010 and $35.7 trillion at 30 September 2010 according to SIFMA.
8 7

As reported by the Securities Industry and Financial Markets Association (SIFMA), www.sifma.org/uploadedFiles/Reserach/Statistics/SIFMA_USBondMarketOutstanding.pdf

Copyright, the Asset Allocation Advisor. All rights reserved. December 2010. www.aametrics.com