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Investment view

Building a mix of assets is one thing but working out how many asset classes to include is a less easy call, says Brian Tora.

Understanding the dynamics of individual asset classes has, as I mentioned last week in this column, become a crucial component of portfolio planning. But what are these individual classes that investors can choose between? In the past, the choice has been perceived as simple and short. Cash, equities and bonds said it all. We live in a more complex investment world today.

Reading a study by my research colleagues, I was intrigued to find that no fewer than nine asset classes were listed and this could doubtless have been expanded further, given that equities represented just one. Nor did cash feature, for the probable reason that this was a technical study examining historic returns, volatility and the likely correlation with other asset classes. With cash, you do know where you are. Nor was residential property included, even though this particular asset features in most people’s financial picture in one way or another.

Bonds divide into four distinct classes – Government, corporate, emerging market and convertible. Each, it has to be said, enjoys different characteristics and are certainly worthy of segregation. With four bond asset classes, commercial property and equities, this still leaves three unaccounted for – hedge funds, commodities and private equity. The reality is that for many investors – those with strictly limited financial resources in particular – these will never feature. But for wealthier investors, the characteristics of these three options will allow a degree of further diversification and the opportunity to construct more sophisticated financial plans.

Returning to equities, despite treating them as a single asset class, the study does go on to point out that there are three distinct groups. Developed equity markets, emerging markets and smaller companies will each contain elements that will require individual research and careful consideration as to how the equity mix in a portfolio is filled. The outperformance of smaller companies over the bigger capitalisation stocks throughout the developed world since markets turned a little over two years ago is a case in point.

This study has gone down well with my investment management colleagues – a band who do not always treat research with the respect that analysts consider is due.

Building a mix of assets to deliver returns to the expec-tation of the investor within definable risk parameters is what it is all about these days. How many asset classes to include is a less easy call to make. We may have more tools at our disposal for reaching investment decisions but there is no evidence that the world is getting easier. Studies such as this are useful, though, to put in context how investment has changed.

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