An asset class is a category or a baskets of assets put together because they share similar characteristics including their risk and return and whether they are growth or income assets. The basic concept of an asset class is relatively straightforward. An “asset class” is a group of securities of some type that have more in common with each other than they do with securities from outside the group.
To some extent, the question of what an asset class is a theological question, on which experts can argue for hours without reaching agreement. For example, you may hear some people define “mid-cap value stocks” as an asset class, while someone else calls “Australian stocks” or “U.S. government bonds” an asset class. If the returns of one asset class is too closely correlated to the returns of another asset class – they might not be in fact separate asset classes. Refer to the asset allocation correlation explained – a simple portfolio article for more information.
Why are asset classes important?
Asset classes are extremely important as they are the buildings blocks of any investment strategy. A number of studies have demonstrated that asset allocation outweighs all other factors in determining an investors return from their investment portfolio.
How is the rate of return on an asset class measured?
The total rate of return on an asset class (that is, dividends plus price appreciation) is measured by the change in an index. An index is a quantitative measure of the total returns that have been earned by some underlying group of securities (be they stocks or bonds) over a fixed period of time. Most indexes are based on market capitalization weighting of the underlying assets.
What is asset allocation?
Asset allocation is the choice and weighting of the asset classes that comprise an investors portfolio based on the investors investment strategy.
There are two very broad categories of assets (a category is not an asset class):-
Defensive – stable income returns, little or no opportunity for capital growth, low volatility
Growth – significant opportunity for capital growth, low to medium level of income returns and often highly volatile
Within the broad categories of defensive and growth there are generally four defined asset classes:
2. Fixed interest (Australian and International)
3. Property (Australian and International)
4. Shares (Australian and International)
These asset class allocations are a little too broad to be all that useful in all but the simplest portfolio constructions. For example within property as an investment class there are further subcategories such residential, office, hotels, retirement and industrial. Each asset class has its own distinct risks and returns and most importantly will be uniquely correlated within your portfolio (also refer to the asset allocation explained – a simple portfolio).