What is an asset class?
Photo: Alvimann. Source: Morguefile
We all know that it pays to be diversified – to spread your investments around. But you need to spread them among different types of investments. Someone who owns 50 tech stocks can hardly claim to have a diversified portfolio. The most basic investment unit is the asset class. But what is this?
An asset class should be a stable group of economic investments that looks similar to each other, but that behaves differently from other investments. They should be investable as a group – say, via an index – and not depend on a manager to get access to the assets. Thus, for example, domestic large-cap stocks are an asset class, while collectibles like fine art or vintage wine is not. Art may appreciate in price, but it has no economic value – it doesn’t generate internal cash flow.
Hedge funds or managed commodity futures are good examples of something that is often treated as a separate class. But most hedge funds use a broad spectrum of assets, so they aren’t internally homogeneous. And they depend on having a skilled manager to get the benefits of their inclusion in a portfolio. Part of what allows top college endowments to perform well is their access to top hedge fund managers. It’s unlikely, though, that a random selection of hedge funds will add much. That’s not to say that the funds are useless, just that in aggregate they tend to cancel each other out. The value comes from successful managers, not from what their managing.
Stocks, bonds, cash, and real estate are broad asset classes. They also have sub-classes, like foreign and domestic issuers, or special types of real estate, like infrastructure or farm land. Asset allocation strategies can vary from conservative to aggressive. The important thing is to understand what you own, and why.
Because investing can get bumpy. It’s only by keeping all your wheels on the road that you can be sure to have enough traction to get through.
Douglas R. Tengdin, CFA