An 'Asset Class' is a group of investments or securities that behave similarly and possess similar characteristics subjected to the same rules and regulations.
Any investor should have basic knowledge of different asset classes like nature, risk, and returns, emerging opportunities to take unbiased and confident investment decisions.
Each asset class is different from other asset classes and differ in its performance. The asset classes are classified based on their nature, risk and return potential, time horizon, correlation with other asset classes and markets, economic environment, rules, regulations, and taxation.
Types of asset classes
Different types of asset classes are (i) cash and cash equivalents (ii) debt/ fixed Income or securities (iii) equity (iv) Commodities and (v) real estate
The equity investments are sub-classified into large-cap, mid-cap, and small-cap.
Equity:
Over the long term, equity outperforms other asset classes, whereas it is risky for the shorter-term. The returns of equity investments are by capital gains and by dividend payments.
The equities investments can be direct through the stock exchange or indirect through equity mutual funds, exchange-traded funds (ETFs), portfolio management services (PMS), national pension scheme (NPS), unit-linked insurance plans (ULIP), private equity investments.
Debt:
Investment into debt is less risky, and returns will be in interest/coupon payments and capital gains. Debt investments can be through bank fixed deposits (FDs), bonds issued by corporates, state, and central government units, pension funds, Reserve Bank of India, small saving schemes, debt mutual funds schemes, debentures, etc.
Commodities:
Commodities investments form into a distinct asset class, and Indians invest in gold and silver. The commodity prices follow a long cycle, so it is crucial to understand the different factors influencing the return prospects, especially for agro-commodities and base metals. Commodities have a low correlation with the other asset classes, so they are excellent for portfolio diversification. Investments in commodities can be made conveniently gold ETFs and commodity mutual funds.
Real Estate:
Real estate investments in residential/commercial units and the land are popular among investors with challenges like clear titles, transparency, transaction costs, etc. The returns are in the form of lease/rental payments and appreciation in prices. Real estate investments are the least liquid than all other asset classes and have a very long time horizon.
Cash:
Cash and cash equivalents are held for immediate payments, emergency funds to grab opportunities by investing in other asset classes. Cash is the only asset class that loses its value over time. One should minimize holding cash to meets current needs. One can consider liquid mutual funds to park money for short durations, convenient, highly liquid, provide superior post-tax returns, and be available with fewer expenses.
Alternate asset classes:
Other asset classes like currency, collectibles, and derivatives. Currency derives its existence due to exchange rate fluctuations between different countries, essential to banks, governments, individuals, and multi-national companies with business in different countries. Derivatives derive the value from the actual underlying asset class used for hedging purposes—collectibles in art, antiques, and other collectibles for some diversification.
Uses of Asset Classes:
Different asset classes act differently in different market conditions. By understanding the usefulness of different asset classes and diversification, one can minimize risks and optimize returns. Diversification works well if asset classes are combined in such a way that they have no correlation or negative correlation with each other. Different asset allocation strategies like dynamic, tactical, and strategic are used based on the investor's risk profile for long-term wealth creation.