What Is an Asset Class?

An asset class is a grouping of investments that exhibit similar characteristics and are subject to the same laws and regulations. Asset classes are thus made up of instruments that often behave similarly to one another in the marketplace.

Understanding Asset Classes

Simply put, an asset class is a grouping of comparable financial securities. For example, IBM, MSFT, AAPL are a grouping of stocks. Asset classes and asset class categories are often mixed together. There is usually very little correlation and in some cases a negative correlation, between different asset classes. This characteristic is integral to the field of investing.

Historically, the three main asset classes have been equities (stocks), fixed income (bonds), and cash equivalent or money market instruments. Currently, most investment professionals include real estate, commodities, futures, other financial derivatives, and even cryptocurrencies in the asset class mix. Investment assets include both tangible and intangible instruments which investors buy and sell for the purposes of generating additional income, on either a short- or a long-term basis.

Financial advisors view investment vehicles as asset class categories that are used for diversification purposes. Each asset class is expected to reflect different risk and return investment characteristics and perform differently in any given market environment. Investors interested in maximizing return often do so by reducing portfolio risk through asset class diversification.

Financial advisors will help investors diversify their portfolios by combing assets from different asset classes that have different cash flows streams and varying degrees of risk. Investing in several different asset classes ensures a certain amount of diversity in investment selections. Diversification reduces risk and increases your probability of making a return.

Asset Class and Investing Strategy

Investors looking for alpha employ investment strategies focused on achieving alpha returns. Investment strategies can be tied to growth, value, income, or a variety of other factors that help to identify and categorize investment options according to a specific set of criteria. Some analysts link criteria to performance and/or valuation metrics such as earnings-per-share growth (EPS) or the price-to-earnings (P/E) ratio. Other analysts are less concerned with performance and more concerned with the asset type or class. An investment in a particular asset class is an investment in an asset that exhibits a certain set of characteristics. As a result, investments in the same asset class tend to have similar cash flows.

Asset Class Types

Equities (stocks), bonds (fixed-income securities), cash or marketable securities, and commodities are the most liquid asset classes and, therefore, the most quoted asset classes.

There are also alternative asset classes, such as real estate, and valuable inventory, such as artwork, stamps, and other tradable collectibles. Some analysts also refer to an investment in hedge funds, venture capital, crowdsourcing, or cryptocurrencies as examples of alternative investments. That said, an asset’s illiquidity does not speak to its return potential; It only means it may take more time to find a buyer to convert the asset to cash.

What Is the Asset Turnover Ratio?

The asset turnover ratio measures the value of a company’s sales or revenues relative to the value of its assets. The asset turnover ratio can be used as an indicator of the efficiency with which a company is using its assets to generate revenue.

The higher the asset turnover ratio, the more efficient a company is at generating revenue from its assets. Conversely, if a company has a low asset turnover ratio, it indicates it is not efficiently using its assets to generate sales.

Formula and Calculation of the Asset Turnover Ratio

Below are the steps as well as the formula for calculating the asset turnover ratio.


$\begin{aligned} &\text{Asset Turnover} = \frac{ \text{Total Sales} }{ \frac { \text{Beginning Assets}\ +\ \text{Ending Assets} }{ 2 } } \\ &\textbf{where:}\\ &\text{Total Sales} = \text{Annual sales total} \\ &\text{Beginning Assets} = \text{Assets at start of year} \\ &\text{Ending Assets} = \text{Assets at end of year} \\ \end{aligned}$​Asset Turnover=2Beginning Assets + Ending Assets​Total Sales​where:Total Sales=Annual sales totalBeginning Assets=Assets at start of yearEnding Assets=Assets at end of year​

The asset turnover ratio uses the value of a company’s assets in the denominator of the formula. To determine the value of a company’s assets, the average value of the assets for the year needs to first be calculated.

1. Locate the value of the company’s assets on the balance sheet as of the start of the year.
2. Locate the ending balance or value of the company’s assets at the end of the year.
3. Add the beginning asset value to the ending value and divide the sum by two, which will provide an average value of the assets for the year.
4. Locate total sales—it could be listed as revenue—on the income statement.
5. Divide total sales or revenue by the average value of the assets for the year.

What the Asset Turnover Ratio Can Tell You

Typically, the asset turnover ratio is calculated on an annual basis. The higher the asset turnover ratio, the better the company is performing, since higher ratios imply that the company is generating more revenue per dollar of assets.

The asset turnover ratio tends to be higher for companies in certain sectors than in others. Retail and consumer staples, for example, have relatively small asset bases but have high sales volume—thus, they have the highest average asset turnover ratio. Conversely, firms in sectors such as utilities and real estate have large asset bases and low asset turnover.

Since this ratio can vary widely from one industry to the next, comparing the asset turnover ratios of a retail company and a telecommunications company would not be very productive. Comparisons are only meaningful when they are made for different companies within the same sector.

Example of How to Use the Asset Turnover Ratio

Let’s calculate the asset turnover ratio for four companies in the retail and telecommunication-utilities sectors for FY 2020—Walmart Inc. (WMT), Target Corporation (TGT), AT&T Inc. (T), and Verizon Communications Inc. (VZ).

What Are Assets Under Management (AUM)?

Assets under management (AUM) is the total market value of the investments that a person or entity manages on behalf of clients. Assets under management definitions and formulas vary by company.

In the calculation of AUM, some financial institutions include bank deposits, mutual funds, and cash in their calculations. Others limit it to funds under discretionary management, where the investor assigns authority to the company to trade on their behalf.

Overall, AUM is only one aspect used in evaluating a company or investment. It is also usually considered in conjunction with management performance and management experience. However, investors often consider higher investment inflows and higher AUM comparisons as a positive indicator of quality and management experience.

Understanding Assets Under Management

Assets under management refers to how much money a hedge fund or financial institution is managing for their clients. AUM is the sum of the market value for all of the investments managed by a fund or family of funds, a venture capital firm, brokerage company, or an individual registered as an investment advisor or portfolio manager.

Used to indicate the size or amount, AUM can be segregated in many ways. It can refer to the total amount of assets managed for all clients, or it can refer to the total assets managed for a specific client. AUM includes the capital the manager can use to make transactions for one or all clients, usually on a discretionary basis.

For example, if an investor has $50,000 invested in a mutual fund, those funds become part of the total AUM—the pool of funds. The fund manager can buy and sell shares following the fund’s investment objective using all of the invested funds without obtaining any additional special permissions.

Within the wealth management industry, some investment managers may have requirements based on AUM. In other words, an investor may need a minimum amount of personal AUM for that investor to be qualified for a certain type of investment, such as a hedge fund. Wealth managers want to ensure the client can withstand adverse markets without taking too large of a financial hit. An investor’s individual AUM can also be a factor in determining the type of services received from a financial advisor or brokerage company. In some cases, individual assets under management may also coincide with an individual’s net worth.

Calculating Assets Under Management

Methods of calculating assets under management vary among companies. Assets under management depends on the flow of investor money in and out of a particular fund and as a result, can fluctuate daily. Also, asset performance, capital appreciation, and reinvested dividends will all increase the AUM of a fund. Also, total firm assets under management can increase when new customers and their assets are acquired.

Factors causing decreases in AUM include decreases in market value from investment performance losses, fund closures, and a decrease in investor flows. Assets under management can be limited to all of the investor capital invested across all of the firm’s products, or it can include capital owned by the investment company executives.

In the United States, the Securities and Exchange Commission (SEC) has AUM requirements for funds and investment firms in which they must register with the SEC. The SEC is responsible for regulating the financial markets to ensure that it functions in a fair and orderly manner. The SEC requirement for registration can range between $25 million to $110 million in AUM, depending on several factors, including the size and location of the firm.

Why AUM Matters

Firm management will monitor AUM as it relates to investment strategy and investor product flows in determining the strength of the company. Investment companies also use assets under management as a marketing tool to attract new investors. AUM can help investors get an indication of the size of a company’s operations relative to its competitors.

AUM may also be an important consideration for the calculation of fees. Many investment products charge management fees that are a fixed percentage of assets under management. Also, many financial advisors and personal money managers charge clients a percentage of their total assets under management. Typically, this percentage decreases as the AUM increases; in this way, these financial professionals can attract high-wealth investors.

Real-Life Examples of Assets Under Management

When evaluating a specific fund, investors often look at its AUM since it functions as an indication of the size of the fund. Typically, investment products with high AUMs have higher market trading volumes making them more liquid, meaning investors can buy and sell the fund with ease.

SPY

For example, the SPDR S&P 500 ETF (SPY) is one of the largest equity exchange-traded funds on the market. An ETF is a fund that contains a number of stocks or securities that match or mirror an index, such as the S&P 500. The SPY has all 500 of the stocks in the S&P 500 index.

As of Mar. 11, 2022, the SPY had assets under management of $380.7 billion with an average daily trading volume of 113 million shares. The high trading volume means liquidity is not a factor for investors when seeking to buy or sell their shares of the ETF.

EDOW

The First Trust Dow 30 Equal Weight ETF (EDOW) tracks the 30 stocks in the Dow Jones Industrial Average (DJIA). As of Mar. 11, 2022, the EDOW had assets under management of $130 million and much lower trading volume compared to the SPY, averaging approximately 53,000 shares per day. Liquidity for this fund could be a consideration for investors, meaning it could be difficult to buy and sell shares at certain times of the day or week.

What Is Asymmetric Information?

Asymmetric information, also known as “information failure,” occurs when one party to an economic transaction possesses greater material knowledge than the other party. This typically manifests when the seller of a good or service possesses greater knowledge than the buyer; however, the reverse dynamic is also possible. Almost all economic transactions involve information asymmetries.

Understanding Asymmetric Information

Asymmetric information exists in certain deals with a seller and a buyer whereby one party is able to take advantage of another. This is usually the case in the sale of an item. For example, if a homeowner wanted to sell their house, they would have more information about the house than the buyer. They might know some floorboards are creaky, the home gets too cold in winter, or that the neighbors are too loud; information that the buyer would not know until after they purchased the house. The buyer, then, might feel they paid too much for the house or would not have purchased it at all if they had this information beforehand.

Asymmetric information can also be viewed as the specialization and division of knowledge, as applied to any economic trade. For example, doctors typically know more about medical practices than their patients. After all, physicians have extensive medical school educational backgrounds that their patients generally don’t have. This principle equally applies to architects, teachers, police officers, attorneys, engineers, fitness instructors, and other trained professionals. Asymmetric information, therefore, is most often beneficial to an economy and a society in increasing efficiency.

Advantages and Disadvantages of Asymmetric Information

Advantages

Asymmetric information isn’t necessarily a bad thing. In fact, growing asymmetrical information is the desired outcome of a healthy market economy. As workers strive to become increasingly specialized in their chosen fields, they become more productive, and can consequently provide greater value to workers in other fields.

For example, a stockbroker’s knowledge is more valuable to a non-investment professional, such as a farmer, who may be interested in confidently trading stocks to prepare for retirement. On the flip side, the stockbroker does not need to know how to grow crops or tend to livestock to feed themself, but rather can purchase the items from a grocery store that are provided by the farmer.

In each of their respective trades, both the farmer and the stockbroker hold superior knowledge over the other, but both benefit from the trade and the division of labor.

One alternative to ever-expanding asymmetric information is for workers to study all fields, rather than specialize in fields where they can provide the most value. However, this is an impractical solution, with high opportunity costs and potentially lower aggregate outputs, which would lower standards of living.

Disadvantages

In some circumstances, asymmetric information may have near fraudulent consequences, such as adverse selection, which describes a phenomenon where an insurance company encounters the probability of extreme loss due to a risk that was not divulged at the time of a policy’s sale.

For example, if the insured hides the fact that they’re a heavy smoker and frequently engage in dangerous recreational activities, this asymmetrical flow of information constitutes adverse selection and could raise insurance premiums for all customers, forcing the healthy to withdraw. The solution is for life insurance providers to perform thorough actuarial work and conduct detailed health screenings, and then charge different premiums to customers based on their honestly disclosed risk profiles.

Special Considerations

To prevent abuse of customers or clients by finance specialists, financial markets often rely on reputation mechanisms. Financial advisors and fund companies that prove to be the most honest and effective stewards of their clients’ assets tend to gain clients, while dishonest or ineffective agents tend to lose clients, face legal damages, or both.