There are various types of financial products such as equity funds, debt funds, NCDs, REITs in which one can invest, to earn returns and grow their money. These products are broadly grouped into Asset Classes.
WHAT ARE ASSET CLASSES?
Assets Class is a collection of various securities that exhibit similar traits as well as comparable responses to market fluctuations. They are governed by similar laws & regulations.
Consider a collection of hair care products including shampoos, serums, conditioner, and hair masks. They are similar in the way that they nourish your hair, and help make it softer and silkier. However, each has different ingredients, constituents, application process, and purpose, and hence one product cannot be replaced by another.
Similarly each asset class is unique in a way. It cannot be replaced by another asset class. Moreover, taxation, liquidity, risk, tenure, volatility varies from one asset class to another.
Investment advisors therefore recommend diversifying portfolios across asset classes to maximise returns and minimise risk.
TYPES OF ASSET CLASSES
There is no standard classification of Asset Classes. But, the most commonly used Asset Classes are:
1. Cash & Cash equivalents
This asset class has the highest liquidity. The purpose of holding this asset class is ease of transaction & accessibility. Apart from actual cash, it includes money market instruments like treasury bills, commercial papers, etc. with a maturity of up to 1 year. Following are the key types of money market instrument;
Treasury Bills: Treasury bills or T-bills are short term debt instruments usually issued by the Central Bank on the behalf of the Government.
They are primarily short-term borrowing tools, having a maximum tenure of 364 days, available at zero coupons (interest) rate.
Commercial Papers: CP is a short term debt instrument that a company issues to raise money from the market for a short period of time, 15 days to one year.
Certificates of Deposits: CDs are short term borrowing instruments issued by a bank. They offer fixed interest rate on the invested amount. The primary difference between a CD and a Fixed Deposit is that of the value of principal amount that can be invested. CD is issued for large sums of money (1 lakh or in multiples of 1 lakh).
Repurchase Agreement: Also known as repos or buybacks. Repurchase Agreements are a formal agreement between two parties, where one party sells a security to another, with the promise of buying it back at a later date from the buyer. The interest rate charged by the buyer for agreeing to buy the security is called Repo rate.
Banker’s Acceptance: A financial instrument produced by an individual or a corporation, in the name of the bank is known as Banker’s Acceptance. It requires the issuer to pay the instrument holder a specified amount on a predetermined date, which ranges from 30 to 180 days, starting from the date of issue of the instrument. It is a secure financial instrument as the payment is guaranteed by a commercial bank.
The downside of this asset class is the returns earned. It is too low and it can’t beat inflation.
2. Equity
Equity as an investment option is very popular and the go-to for people who look at earning higher returns. However, this asset class is subject to higher market volatility and thus the risk is also comparatively higher.
There are various types of Equity Investments options available. Following are some of the key types available to investors in India.
Shares: Shares are units of ownership of the company. Buying shares makes the person a shareholder in the company and entitled to profits in proportion to his/her shareholding.
Mutual Funds: Equity Mutual Funds pool the money of investors to purchase shares of a group of companies. Mutual Funds are considered relatively less risky than investing directly in shares.
Futures & Options (F&O): They are types of stock/share derivatives traded in the market. These are contracts signed by two parties for trading a stock / share at a predetermined price on a later date. Such contracts can be used to hedge market risks involved in stock market trading by locking in the price beforehand.
The price of an F&O contract is derived from an underlying asset such as shares, stock market indices, commodities, ETFs, and more.
Being a derivative product its performance is specifically dependant on the performance of the underlying asset i.e. stock or index they are derived from.
F&O investor buys units of a futures contract by estimating whether the price of the underlying share or index will go up or down in the future. Trading in Futures & Options requires one to be well-versed with the stock market.
Arbitrage Schemes: It refers to buying and selling of the same or similar performing asset at the same time on two different exchanges or exchange periods to take advantage of the price differential. The temporary price differential lets traders lock in profits.
If you find it difficult to sport Arbitrage opportunities in the stock market, you can invest in arbitrage mutual funds.
Arbitrage schemes primarily invest in equity & derivatives market.
An arbitrage trade is of low risk, however, the margins earned are very thin.
3. Fixed Income
This is one of the oldest types of investment products. Fixed Income products pay regular return until maturity. They are considered relatively less risky than equity products. There are many types of Fixed Income Products; the following are the most commonly known products.
Fixed Deposits: These are the most trusted investment options for many. Fixed Deposits are offered by banks, non-banking finance companies (NBFCs), and companies. They give a fixed interest rate which varies across financial institutions.
Recurring Deposits: It is a type of investment where you invest a fixed amount of money every month. The interest rate is the same as that of fixed deposits. This enables retail investors with small amounts of money to generate a good corpus of wealth in the long run.
Bonds: These are issued by corporates & government as a form of borrowing for business expansion or new projects. Bonds have a fixed tenures and offer guaranteed returns. Once bonds mature, the interest generated is added to the invested amount and given back.
National Savings Certificate: National Savings Certificate or NSC is a type of fixed return instrument backed by the Government of India. NSC certificates can be bought from any post office in the country. NSCs come with two maturity periods – 5 and 10 years.
Public Provident Fund: PPF is a tax-free savings scheme regulated by the Indian Government. It has a lock-in period of 15 years. Individuals can start PPF accounts with a minimum amount of Rs.500 pa. With its attractive interest rates and tax benefits, PPF is a big favourite with small savers.
Debt Mutual Funds: These funds invest the pooled money of the investors in various types of fixed income securities, such as corporate and government bonds, commercial papers, money market instruments, corporate bonds, etc.
Non Convertible Debentures: NCDs are financial instruments that are issued by companies to raise longer term debt capital. They have a fixed tenure and people who invest in it receive regular interest at a fixed rate.
Senior Citizen Savings Scheme: An individual of age 60 years or more can invest in SCSS. It aims to provide financial security to the senior citizens of India. SCSS pays an interest rate fixed by the Ministry of Finance.
4. Real Estate
As the name implies, this Asset Class focuses on houses, villas, plots, commercial building, etc. The Real Estate asset class, unlike other asset class, is considered as a tangible investment class. Earnings from Real estate are in the form of rent/lease payments and price appreciation. Real Estate is the least liquid of all asset classes and generally is very long-term in nature.
Real estate investment trusts (REITs): REITs can be described as a company that owns and operates real estates to generate income. When an individual invests through a REIT, they are buying shares of a corporation that owns real estate properties and distributes practically all of its income as dividends.
REITs provide income to its investors via:
a. Dividends / Interest Income
b. Price Appreciation of its shares
5. Commodity
They are goods and products that can be bought & sold. Examples of Commodities are gold, silver, petroleum products, bronze, food crops etc. Gold & Silver are the most commonly traded commodities in India. The performance of this asset class is independent of the stock market and hence provides good diversification.
With the launch of Gold bonds & ETFs, investment in commodities has become more convenient for the new-age investors.
Sovereign Gold Bonds: These are denominated in grams of gold. You can buy it in multiples of 1 gram (gm). The minimum investment is 1gm and the maximum is 4kgs, per investor. Gold bonds give an annual rate of interest of 2.50% over and above the gold price appreciation.
ASSET ALLOCATION & INVESTMENT PORTFOLIO
We now know the key asset classes and also understand that risk and rewards in each of them is different. A balance between risk and reward is attained by investing your money across different asset classes instead of investing in just one avenue, based on your investment objections, horizon and risk appetite.
An Investment Portfolio is a collection of investments across equity, cash or cash equivalents, fixed income, commodities, in general across asset classes, prepared, monitored, and adjusted such that the individual’s financial goals & timelines are achieved.
For example, an investor can protect himself from potential losses in equity market due to market fluctuations, by investing a part of that money into commodities which tend to move in opposite manner to equity markets.
Asset allocation is thus an investment strategy that aims to balance risk and reward, by creating a portfolio that includes investments across different asset classes. The proportion ascertained to each asset class depends on an individual’s goals, risk appetite, timelines, and cash flows.
Example: Investment Portfolio & Asset Allocation of a Conservative Investor
CONCLUSION
A basic understanding of asset classes is necessary to create well-balance portfolios. Asset Allocation strategies requires research and being mindful of market fluctuation. Consulting an investment advisor or wealth manager is another option.
A diversified portfolio works better in achieving your goal because the overall return is not affected due to lag in one asset class. The market performance of different asset classes is not usually linked.
