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The four key asset classes

How to use the four main asset classes to build a diverse investment portfolio

by Jennifer Banfield
20 December 2017, at 11:51am

Investment funds can invest in many different types of asset class. To shed light on this, four of the main asset classes (aside from cash, which most people already have a good grasp of) are summarised below. 

Equities 

Company shares, or equities, are what people often imagine when they think about investing. Buying shares is essentially buying a piece of a company. Companies offer shares to raise money. The value of shares can grow and offer investors an opportunity to benefit from the profits of a company – either by means of dividend payments, growth in the share price or a combination of the two. 

Shareholders receive money on a regular basis, known as a ‘dividend’, which is a portion of the company’s profits. It is up to the company to decide how much profit to distribute as dividends and how much to retain to fund growth and expansion. Just as a share price can go up or down depending on, for example, how well investors believe the company is doing, dividend payments can go up and down or be stopped altogether. Regular dividend payments are often considered a sign of company strength.

For those who want to invest without owning a property, investing in real-estate funds can be a solution

Property 

For many, investing in property means buying a home or becoming a landlord. Buying property involves large, upfront sums of money for a deposit and buying and selling costs. It is difficult to retrieve the money quickly if it is tied up in property. For those who want to invest without owning a property, investing in real-estate funds can be a solution. Many of these invest in commercial property, ranging from shopping centres to industrial estates and so on. There are many types of property funds, including real-estate investment trusts, shares in listed property companies, property investment trusts, and property unit trusts. Real estate can be a good way to produce income because the properties can be rented out to provide a regular income. As managers of property funds invest in many properties, this spreads the risk of a development not being finished or a property not having any tenants.

Bonds 

Investing in fixed income usually means investing in bonds – a type of IOU issued by a government or company in exchange for a loan from investors. 

Bonds are issued when a company or government wants to raise money. They are normally designed to pay regular interest (a ‘coupon’) and return the original loaned amount at a set date (a ‘maturity date’). The UK government issues bonds, more commonly known as gilts. Gilts are generally considered one of the safest types of bond because the government is not expected to default on the loan. As a result, you can expect interest and your original investment back. Bonds are often graded depending on how likely it is an investor will receive their interest and money back. 

There are independent rating agencies (such as Moody’s and Standard and Poor’s) that try to calculate the risk and grade bonds in line with this, usually using a lettering system: AAA is the highest credit rating, moving down through AA, A, BBB and so on. The lower the credit rating, the greater the risk of the company defaulting and not honouring its debt. Lower-rated securities must attract investors by offering higher coupons (or rates on return). 

Alternative investments 

We use the term ‘alternative investments’ to describe investments that are not company shares, traditional bonds or traditional property investments, or cash. 

Examples of alternative assets include commodity investments (such as gold), absolute-return investment funds (designed to make money in all market conditions) and infrastructure investments (for example, linked to building for housing, hospitals and schools).

Alternative does not necessarily mean higher risk. We consider some alternative investments to be higher risk, like commodities that have highly-volatile price movements, but others as being lower risk and among the expected lowest-risk funds we may hold in our portfolios. Alternative assets can have a low correlation (their price may not move closely in line) with more traditional asset classes such as company shares and bonds. This immediately highlights a potential attraction of these assets within a well-diversified portfolio.