Risky Business (Part 2)

What is an asset? If different risk factors affect the different asset classes differently, what does that mean?

An asset is something that provides a return. A financial asset provides expected future financial return. If it’s a bond or loan, the cash flows to the lender or bondholder come before any cash goes to the owners. We say those claims are senior. Usually they’re fixed by some kind of contract, and due to pay off in a fixed time-frame. That makes bonds quite stable.

If it’s equity or stock, the cashflows are junior, or residual. The equity holder gets what’s left over after the employees are paid, the bills are paid, and the taxes are paid. Equities are more risky because that cashflow stream is more variable. Obviously, if the business grows or becomes more efficient, stockholders benefits the most.

If it’s land, or real-estate, that cashflow comes from operations. It’s often senior even to bonds. The payments are contractual, but as long as the business stays there, there’s no maturity. Since rents can vary, real-estate is often more risky than bonds, but less so than stocks.

These are the three principal financial assets: stocks, bonds, and real-estate. (Cash is just a short-term bond.) By mixing and matching risk factors with asset classes, portfolio managers build portfolios that can meet specific goals in an efficient manner. That’s how use risk to benefit investors.

Douglas R. Tengdin, CFA
Chief Investment Officer
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