Get to Know Various Types of Asset Classes
- Major traditional and alternative asset classes
- The role of alternatives in a portfolio
- How diversification works across asset classes and investments
What are traditional asset classes?
The major asset classes include bonds, cash and stocks. Bonds and cash have traditionally been viewed as defensive asset classes that many investors use to provide a source of regular income.
Stocks, alternative investments and property, on the other hand, are considered growth assets that aim to boost long-term capital appreciation.
Each asset has its own risk/reward profile. While cash is considered to carry the least risk, it also has the lowest return potential. Conversely, equities and alternatives may carry greater risk but also offer higher return potential.
In uncertain markets, investors may hold larger than usual amounts of cash in an attempt to reduce their risk exposure. It may be possible, however, to prudently take on more risk and incrementally step-up return potential while still managing volatility.
The Relationship Between Risk and Reward
What are alternative asset classes?
There is no single definition of what constitutes an alternative asset class and so the term covers a broad range of investments. Generally, alternative investments encompass those outside the mainstream classes of stocks, cash, and bonds.
Examples of alternative investments include commodities, private equity, infrastructure, real estate, and hedge funds. Previously designed for institutional investors, alternative investments are now available to individual investors through alternative investment funds.
Alternative assets are generally included in a portfolio for two key reasons:
- Diversification: They represent a different source of risk and return for a portfolio.
- Inflation hedge: Inflation can have a big impact on return. Rounding out a core portfolio with non-traditional and inflation-hedging assets can help investors pursue opportunities across economic environments.
For example, in higher inflationary environments, assets such as real estate and commodities may perform better (as illustrated in the chart below).
What’s the role of diversification?
A well-diversified portfolio is split across asset classes as well as among investments within each asset class. Maintaining a diversified portfolio can help investors prepare for shifts in the economy and interest rates, providing the potential to not only capture opportunities but also minimize risks associated with overconcentration in one asset class.
Diversification within equities can be achieved by investing in stocks from different sectors, countries, and companies. Diversification in bonds can be similarly achieved by investing in different sectors, countries, issuers, and bond types.
Disclosures
A word about risk: All investments contain risk and may lose value. Investing in the bond market is subject to risks, including market, interest rate, issuer, credit, inflation risk, and liquidity risk. The value of most bonds and bond strategies are impacted by changes in interest rates. Bonds and bond strategies with longer durations tend to be more sensitive and volatile than those with shorter durations; bond prices generally fall as interest rates rise, and low interest rate environments increase this risk. Reductions in bond counterparty capacity may contribute to decreased market liquidity and increased price volatility. Bond investments may be worth more or less than the original cost when redeemed. Equities may decline in value due to both real and perceived general market, economic and industry conditions. Alternatives involve a high degree of risk and prospective investors are advised that these strategies are appropriate only for persons of adequate financial means who have no need for liquidity with respect to their investment and who can bear the economic risk, including the possible complete loss, of their investment. Diversification does not ensure against loss.
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