Jezri Mohideen considers the four main asset classes within the context of asset management

Posted by on Jan 27, 2015 in Blog | Comments Off

Jezri Mohideen considers the four main asset classes within the context of asset management

Asset management in the financial sense refers to the management of investments by financial services providers (very often investment banks) on behalf of their clients. These clients typically include pension funds, insurance companies, businesses, charities and other not-for-profit organisations and high net worth individuals. For anyone who wishes to understand what is involved in asset management, it is useful first for all to consider the characteristics of these ‘assets’. The four groups of assets that most commonly form the basis of an investment portfolio are cash, fixed interest assets such as bonds, shares and property. They each feature a different risk profile and each present challenges from an asset management point of view. The risk profile of different asset classes can shift, depending on market conditions, as can be seen from financial news articles from the risk management expert, Jezri Mohideen. For an investor, it is common for all four to be present in an investment portfolio to ensure that the portfolio is suitably diversified in terms of risk and growth potential.

Jezri Mohideen

Cash assets

In terms of risk, cash based investments are the most basic and safest forms of investment. From the point of view of an individual investor in the UK, cash deposits are highly secure, given that deposits up to the value of £85,000 are guaranteed against the failure of a building society, bank or credit union under the Financial Services Compensation Scheme. Cash investments include not just deposit accounts, but also certain cash-based money market funds, which include loans to governments, banks or companies made for short periods of time – typically one to three months.

A benefit of investing a certain proportion of assets in cash is that it offers a high degree of liquidity; meaning that the investment can be accessed quickly and easily if a sudden need for capital expenditure arises. From the point of view of a business, a certain level of liquidity may be desirable to cover situations where capital is required at short notice, for example to purchase new plant and equipment to cover unexpectedly high demand.

In the current era of historically low interest rates however, the growth potential for cash investments is limited. This is especially true in the case where the rates of return achievable are not materially higher than the rate of inflation, where there is over-reliance on cash investments, the danger is that although the nominal value of the investor’s assets may stay intact, the real value of those assets could fall as spending power is lost. As a consequence, although an asset manager may include an element of cash-based investment in a portfolio, it is highly unlikely that such investments would form the bulk of that portfolio.

Bonds

Bonds are instruments whereby governments and companies borrow money from investors in return for the payment of interest and the full value of the initial stake at a specified date, referred to as the redemption date. The interest rate recoverable is determined in advance of purchasing a bond – although in some cases (such as UK Government index-linked gilts), the interest may relate to a price index.

In the case of government bonds – and assuming the bonds are purchased from the governments of sound economies, the risk of default is low. With corporate bonds, the risk may be higher, depending on the stability of the company. To compensate for this risk, the interest rates achievable from such corporate bonds are also likely to be higher.

Although bonds are by no means a risk free method of investment, they can play an important part in providing an investor with a steady and predictable income stream. They can also be a useful method of diversification as they tend to have an inverse relationship with the performance of equities. The choice of bonds requires specialist asset management experience – as does deciding the extent to which a portfolio ought to consist of this type of investment.

Equities

Equities, also known as shares, are issued by companies as a means of raising money. They hold a double advantage for investors; namely, the potential for an annual or bi-annual dividend payment and the promise of capital growth if the value of the shares increases.

Their long-term performance, historically, has been strong in comparison with other asset classes. The volatile nature of stock prices in the short term, however, means that this type of asset should not generally be seen as a reliable short-term investment. Choosing which companies to invest in requires careful consideration not just of the specific information concerning that company, but also of the relevant industry sector as a whole. In addition, fund managers need to consider the risks investors are exposed to across their portfolio.

Property

There are various ways of investing in property, from direct purchase with a view to taking advantage of the buy-to-let market through to investing in funds that invest directly in commercial or residential real estate. Property offers the potential for growth along with rental income. It is also possible to buy shares in companies that buy and sell or develop properties. Tying up cash in property can have implications for liquidity – something which is less of an issue where the investment is in a property fund or property-related equities. Investment in a property fund also means that exposure to risk is spread across a range of assets.

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