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Asset Classes – Know your bonds from your shares?

 

What is an asset class?

An ‘asset class’ is a group of investments with similar financial characteristics.

The main asset classes are equities, bonds, property, commodities, alternatives and cash. It is usually a good idea to hold a mixture of asset classes in an investment portfolio to diversify risk.

 

Equities (Stocks and Shares)

Equities, also known as Stocks or Shares, are probably the most well-known type of investment. Equities represent an actual ownership interest in a company. If you buy some company shares, then you own a portion of that company. You hold ‘equity’ in that company.

Shareholders typically have rights, such as being able to vote on matters at the company annual general meeting (AGM) or are entitled to a dividend payment (income paid to shareholders) should the company directors decide to pay one.

Shares can be ‘public’ or ‘private’. Public companies have shares that are traded on a stock exchange and can be bought by anyone. Private company shares are not usually available to the public.

The share price is determined by supply (number of shares in circulation) and demand (how much people are willing to buy the shares for). If the company does well commercially, so more people want to buy those shares, the price of the shares will usually rise. If the company doesn’t do so well the share price will typically fall.

 

Bonds

Governments and companies can issue bonds to raise money. By purchasing a bond, you are giving the government or company your cash for the promise that they will pay you back on the ‘maturity date’ in the future. Plus, they will pay some regular interest on top – referred to as the ‘coupon’. Essentially a bond is an IOU.

Within the investment industry, bonds are also referred to as fixed-income investments (due to the fixed coupon).

People can sell their bonds to other investors before the maturity date. This is called the ‘secondary market’, as you are not buying directly from the government/company. The debt is transferred to the person who now owns the bond.

The price paid on the secondary market will be different from when the bond was originally issued. Factors that change this include; time to maturity, government interest rate change and whether the company is more/less likely to default on the debt.

 

Property

The property asset class is investment in physical land or buildings. You can receive income from rent and potential gains from the property rising in price. Usually, property is split into three types: commercial, industrial and residential.

Many investment managers invest indirectly into property. Usually, this means a fund that pools money from different investors and then purchases properties, giving the investors a spread of different property assets.

Another common way of gaining exposure to property is through buying shares in companies such as British Land, Land Securities etc.

These companies buy properties, sometimes borrowing money to do so, and generate a return by renting them out and/or developing them to sell at a higher price. If more than 90% of their profits are distributed to shareholders, they qualify as a ‘real estate investment trust’ (REIT) which has tax advantages.

A basket of REITs can be constructed in an ETF (exchange-traded fund), giving investors a diversified mix of REITs.

Whilst the day-to-day price movement of REIT ETFs can be similar to that of the broader stock market – over the long run, performance is driven more by the property market. This makes it a useful diversification tool within portfolios.

 

Commodities

A commodity is a basic good. ‘Hard’ commodities are usually mined or extracted, such as metals and oil. ‘Soft’ commodities tend to be agricultural products, such as wool, sugar and coffee.

Commodity prices can be highly affected by world events. For example, disruption in a country supplying oil may reduce the world supply, leading to an oil price increase. Speculators can be drawn to commodity markets to try and make a quick gain, which can create volatility.

Like property, you can gain exposure to commodities through funds. An ETF can be used to track the price of commodities. It can be useful to have commodities in your investment portfolio to further diversify particularly as a hedge against higher than expected inflation.

 

Alternatives

The alternative asset class is for investments which have a more complicated structure and don’t quite fit into the categories above. These can include hedge funds, private equity, infrastructure and many more.

It is important to differentiate between the risks posed by hedge funds that are unregulated and/or leveraged, and those run within the tightly regulated UCITS¹ legal structure. This structure means an independent auditor and custodian must be appointed by the investment manager which ensures that positions are reported accurately and restrictions that stop them from employing overly concentrated or leveraged positions are enforced. At Tiller, we only invest in UCITS regulated hedge funds.

Because these types of investments perform in a different way to the more mainstream asset classes, such as bonds and equities, alternatives are a useful diversifier.

 

Cash

Cash is often considered the safest of asset classes. Cash is perfectly liquid and can easily be exchanged for goods and services. Cash doesn’t have capital risk, so you won’t lose money by holding it.

With low risk comes low return. The amount you can earn on cash tends to be minimal, due to low interest rates. In addition, inflation (the increase of prices over time) eats into the real value of your cash. £100 today will have less buying power in the future.

Holding a certain amount of cash is a good idea. You need cash for day to day expenses and emergencies. You should build up some cash prior to investing as a safety buffer.

 

How we build a portfolio

We use our investment expertise and technology to build a portfolio for each client suitable to the level of risk they’re willing to accept. Using a mixture of ETFs and active funds the portfolio will have exposure to multiple asset classes and sectors.

See the portfolio we can build for you for free in our discovery area.

 

 

¹ UCTIS stands for Undertakings for Collective Investments in Transferable Securities. The term refers to EU Directive 85/611/CE of 20 December 1985, the objective of which was to create a single European market for retail investment funds, while at the same time ensuring a high level of investor protection.

 

Disclaimer:
The views contained herein are not to be taken as a recommendation or advice. Any forecasts, figures, opinions or investment techniques and strategies set out are for information purposes only, based on certain assumptions and current market conditions and are subject to change without prior notice. A mandatory sell of a theme may result in a taxable capital gain or loss. All information presented herein is considered to be accurate at the time of production, but no warranty of accuracy is given and no liability in respect of any error or omission is accepted. It is very important to do your own analysis before making any investment based on your own personal circumstances. You should take independent financial advice from a professional in connection with, or independently research and verify, any information that you find on Tiller’s website and wish to rely upon, whether for the purpose of making an investment decision or otherwise. It should be noted that investment involves risks, the value of investments may fluctuate in accordance with market conditions and investors may not get back the full amount invested.


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