Asset Classes (2019)

Asset Classes

What are the Asset Classes?

We define an asset class as a set of goods or securities (equity, debt or contracts) which exhibit the same characteristics, behave in the same way on the market and are governed by the same rules. This blog explores several Asset Classes with examples.


Furthermore, an asset must be able to be traded on an organized market and generate an income and/or capital gains in the future. The main purpose of acquiring an asset is an investment, i.e., to seek a return.


This section begins with a review of the different asset classes and, more importantly, an analysis of the risks associated with each. Asset price fluctuations depend on whether or not different factors, or more precisely risks, materialize, and these risks are usually specific to each class.


The list of risks will be as comprehensive as possible. At the end of this section, we will classify the asset classes according to their degree of risk using several criteria.


Money Market Investments

Money market instruments include all short-term instruments with a maximum maturity of 12 months.

These are highly liquid, high-quality debt investments that generate a modest yet regular income, such as government debt securities, certificates of deposit, commercial paper or fiduciary deposits.


For private management, in terms of the form of investment, fiduciary investments are usually distinguished from money market funds. Although bonds with a maturity of less than one year belong to the money market category, they will not be considered in detail here as they are covered in the next section.


A fiduciary deposit is an investment made in the name of a bank, in the form of a short-term deposit in another bank, but on behalf and at the risk of the investor, who therefore bears the risk of default or bankruptcy of the borrower. Counterparty risk may be mitigated by demanding a minimum rating or by counterparty diversification.


As the loan is instigated by the lender, a lower interest rate is justified. This is a useful means of financing for banks, allowing them to borrow money at a better rate from their clients. The interest and principal are paid at maturity.


A money market fund invests in short-term debt securities of the highest quality. Income may be distributed or capitalized. Their main advantage over fiduciary investments, which often impose a fixed term, is their high liquidity. However, this type of investment can undergo price fluctuations over time because of the greater variety of investments.


Finally, the choice between these two types of investment rate will be influenced by the rate of income and capital gains tax in the investor's country of residence.



A bond “represents a fraction of a loan made to a company or a public authority by a large number of investors. This type of security is issued in series, with the same issue price, interest rate, maturity and repayment conditions.” These are debt instruments with maturities of over one year, as short-term bonds are regarded as money market instruments.


In principle, investors who buy bonds get a regular return, paid out in the form of interest (coupons), and can also make a capital gain if the initial purchase price was lower than the resale price or redemption value. Bonds bought with the intention of being held until maturity should be distinguished from bonds bought for a shorter period with speculative intent.


A bond's total return can be defined as follows:


a) Types of Bond

Firstly, regular fixed-rate bonds are to be distinguished from zero-coupon bonds which, as their name implies, pay no interest, but make a capital gain when redeemed at maturity. These bonds are bought at a substantial discount to par value, i.e., below 100%, and are redeemed at par (100%).


Floating rate notes pay a coupon that varies over time. The coupon is equal to a reference rate like the LIBOR, plus a spread, i.e., a certain percentage (for example, LIBOR + 2%). In this case, investors are affected by interest rate fluctuations between two coupon dates.


Perpetual bonds have no set maturity and pay fixed coupons for life. Because of their “infinite” maturity, they are very sensitive to interest rate fluctuations and can experience major price fluctuations.


Consequently, they should only be considered by investors seeking to earn a fixed income over time, who are unconcerned about the fluctuation of the bond's value.


Perpetual bonds are often “callable”, giving the issuer the right to redeem the loan before maturity at a predetermined date and price. By exercising this option, the issuer can refinance at a lower rate if interest rates have dropped significantly since the initial date of issue.


This type of clause reduces the bond's value for investors, as they run the risk of being redeemed before maturity and having to reinvest at a lower rate.


Some bonds are “puttable”, meaning the holder is entitled to request early repayment at a predetermined price. However, they are rarer in practice and, because of this right to early redemption at the holder's request, more expensive.


Inflation-linked bonds provide protection against this threat and help preserve real value over time. Technically, every year, the nominal amount is adjusted to inflation based on the consumer price index. The coupon rate remains the same, but the nominal amount varies over time. However, this type of bond has low liquidity.


Finally, convertible bonds allow the holder to convert the bonded debt to stocks (equity) according to defined conversion procedures, but they are not commonly encountered in practice.


b) Types of Bond Issuer

The first distinction in terms of issuer lies between government, sovereign or supranational bonds and corporate bonds. As we mentioned earlier, government bonds with a maturity of fewer than 12 months, such as American Treasury bills (T-bills) or German “Bubills”, are considered money market instruments because of their maturity, in the same way as commercial paper or certificates of deposit.


Government bonds from developed countries are high-quality debt instruments, but their creditworthiness depends on the country in question and the state of its finances. Greece is a recent example of a developed country with worrying financial health. Bonds from most emerging countries are of lower quality, due to greater uncertainty about their ability to repay their debts.


By emerging countries, we mean all countries that are not considered advanced. According to the criteria defined by the International Monetary Fund (IMF), the 33 advanced (developed) countries are.


However, in the current economic environment, it is important to examine the level of indebtedness of the country in question carefully and to favor those with solid finances. It appears that several countries still do not respect the


Maastricht criteria, which set the upper limits of indebtedness at 60% of GDP for public debt and 3% for the budget deficit. It can also be useful to study the distribution of the debt to find out who the other creditors are. This is particularly true of Europe, a club where everyone “knows everyone else”.


Moving on to corporate bonds, it can be worthwhile to classify these according to company type and, more importantly, industry. In our view, an in-depth examination of the outlook of the industry in which the company operates, as well as the company's fundamentals, is key to determining the quality of the issuer.


The type of issue is also essential, as it determines the level of creditor protection in case of bankruptcy. Subordinated bonds pose an additional risk to creditors, as they are only entitled to have their debt repaid once the other (priority) creditors have been repaid. Bonds with an embedded call option also pose a risk to creditors.


Bonds issued by companies that benefit from a State guarantee or, because of their capital structure, benefit from an implicit State guarantee, also exist. They are generally of a quality equivalent to government bonds but offer lower returns than ordinary corporate bonds of similar quality.


c) Issuer Quality, Credit Rating Agencies, and Bond Rating

Bondholders seek first and foremost a regular return in the form of coupons. However, interest is not paid if the issuer goes bankrupt or finds itself in default. Consequently, the choice of bonds should be based on the credit quality of the borrower.


Investors can refer to the rating assigned by credit rating agencies to determine the quality of an issue. Standard & Poor's, Moody's and Fitch are the main credit rating agencies.


To rate the loan, they carry out a detailed analysis of the company's economic sector and financial state. The interest rate at which the company is able to finance itself on the market directly depends on the rating obtained and therefore determines the cost of financing.


Loans rated AAA are the most creditworthy, and the lower limit for investment grade bonds is BBB (Standard & Poor's), at which creditworthiness remains adequate. Under this threshold, bonds do offer higher returns (they are called high yield bonds) but they carry a higher risk of default.


Bond issues with a BB to B rating are not very creditworthy. Bonds with a CCC to D rating is vulnerable to non-payment and are therefore highly speculative securities. It is important to note that a rating applies to a specific debt issue and not to a company. Subordinated bonds issued by the same borrower will have a lower rating than regular bonds.


As such, it is useful for investors to study the rating of the bond issue before making an investment decision.

Rating agencies can sometimes be slow to change ratings, and the subprime crisis has caused doubt as to their precision and reliability. Moreover, besides the increasing complexity of products requiring analysis, the fact that these agencies are paid by issuers can lead to potential conflicts of interest.


These ratings are a good indication of creditworthiness, but cannot by themselves justify an investment decision. As we suggested earlier, an analysis of the industry and its prospects must also be carried out.


In addition, we recommend examining trends in prices for Credit Default Swaps (CDS), which “provide precious information about the perception investors have of debtor risk”.


These instruments will be covered in more detail in the following subsection on risks.


d) Forms of Bond Investment

Investors can decide to invest directly in individual bonds or in bond funds, but management fees and expenditure involved in these funds often affect their performance. Another option is a bond index tracker, i.e., a fund that replicates the performance of such indexes. Passive (or index) management is often favored where bonds are concerned.


e) Taxation of Bonds

Coupons paid are regarded as income and are taxed at various rates depending on the country. Capital gains, however, are treated differently in different countries. For example, capital gains are taxed in France, while in Switzerland there is no capital gains tax on private property.


Other Asset Classes

Aside from currencies, which are often regarded as an asset class, we might consider including other assets such as aircraft or boats, as income is generated by their rental or commercial exploitation.


However, given the depreciation over time of these assets, maintenance and exploitation costs, and the limited number of individuals who own private jets or boats intended for hire, they should instead be regarded as the “non-investment, for personal use” part of an individual's fortune.


The same reasoning applies to cars, with the exception of vintage cars whose value can grow significantly over time. This type of investment can, therefore, prove very profitable.


The same is true of all collectors' items or artworks whose value can appreciate with time to be sold for more than their purchase price. Finally, we might consider wine and bottles of future “grand crus” that are also likely to grow in value over time.


In our view, however, all the goods we have just listed depend on one essential factor: passion. Individuals have personal interests and particular pastimes and hobbies they are willing to spend money on.


So although these assets to become part of an individual's fortune, they are acquired not as an investment but rather as the realization of a dream or pursuit of a passion. These decisions are based on deep personal motivation and less on the profit motive.


A sailing or car enthusiast will buy a yacht or a vintage car. A modern art lover will buy work by his or her favorite artist for the pleasure of owning it and being able to contemplate it at home.


In the event that the work should be sold, this art enthusiast would probably use the proceeds of the sale to buy another one. As for wine, a “grand cru” is intended above all to be enjoyed on a grand occasion or at a special event, and the pleasure it gives to the palate is the main objective sought by wine lovers.


Obviously, some of these goods may be bought with a view to speculation, i.e., quick resale in order to make again on the capital invested. However, the market for this type of goods is often illiquid and valuation includes a significant level of subjectivity.


Furthermore, the value is often related to the uniqueness of the item and its history. Finally, the term speculation often refers to short-term objectives, while the holding period of this type of asset is usually long and is not a factor that is appreciated objectively by an enthusiast.


For all these reasons, we do not consider these goods as “normal” investment assets as far as this analysis is concerned, although we recognize that they can be regarded as such, marginally, for some investors.


Particular Forms of Investment within Asset Classes


Hedge Funds

By definition, hedge funds have an absolute return objective, allowing managers to take long and short positions on the market, rewarding them with performance-related commissions and allowing them a great deal of flexibility in terms of investment style and approach. Managers adopt a more active management style and seek to profit from the market's various inefficiencies.


“A hedge fund is a private investment association that uses a large range of financial instruments such as short selling of stocks, derivatives, leverage or arbitrage, all in different markets.


Usually, the managers of these funds invest part of their own resources and are paid according to their performance. Hedge funds often require high minimum investments and access to them is limited. They are intended mainly for wealthy clients, whether private or institutional.”


Therefore, hedge funds should not be regarded as an asset class, but rather a particular investment strategy. Furthermore, because of the diversity of strategies used and the fact that returns are derived from the return made on other traditional asset classes, it cannot be maintained that hedge funds have the specific characteristics necessary to be regarded as a separate asset class.


It is possible to invest directly in individual hedge funds, or indirectly in funds of hedge funds, which provide diversified exposure to several different funds and management strategies. Selecting the best fund of hedge funds, adapted to market cycles represent the added value essential in the management of this type of product.


Although hedge funds will not be studied comprehensively as part of our analysis, we will address the importance of the strategy used by the fund manager. It is particularly worth mentioning the following strategies, which clearly argue in favor of inefficient markets and are useful in demonstrating a flexible approach to investment.


Equity Long-Short

Funds using this strategy identity, on the one hand, undervalued stocks (long or buy positions) and, on the other hand, overvalued stocks (short or sell positions) in certain regions or market segments. They bet on the fact that sooner or later the liquidation of these positions will generate capital gains.


In the Equity Long-Short strategy, there is no ongoing search for beta neutrality in terms of market risk. However, for so-called Equity Market Neutral strategies, managers seek a beta neutral position (long side beta = short side beta), i.e., the sums of the betas for the long and short positions are equal.



Arbitrage strategies aim to exploit price differences in markets for identical or similar investments. These strategies include fixed income arbitrage, convertible bond arbitrage or mortgage-backed securities arbitrage



Managers who apply these strategies aim to exploit certain events, such as coming changes in companies (mergers, acquisitions, restructurings, remediation, etc.). Merger arbitrage, distressed securities, and special situations strategies also belong to this category.


Global macro

Hedge funds that pursue these strategies attempt to identify macroeconomic developments early (changes in interest rates and exchange rates in particular), and profit from them. Growth funds and emerging market funds are both parts of this category.


Managed Futures

In this category of hedge fund, futures contracts are traded on financial instruments, currencies, and commodities. As we mentioned previously, flexibility is an essential factor and it will form the basis of the approach to portfolio construction suggested later. If hedge funds manage to generate attractive returns with less historical volatility, this is due in part to the flexibility of their investment policy.


Furthermore, relatively illiquid markets offer bigger investment opportunities, specifically because they are less efficient. As Swensen points out, “The most lucrative investments tend to be located in shady areas, rather than under Wall Street's spotlight.”


Before briefly presenting the risks associated with this type of investment, it is interesting to note that some studies indicate that hedge fund returns cannot be adequately approximated by commonly used statistical distributions such as normal distribution. This is consistent with our earlier conclusion about risky assets.


Risks Associated with Hedge Funds

This type of strategy does include a set of market-related risks, particularly liquidity risk and leverage risk. In fact, quarterly or semi-annual liquidity periods strongly affect entry and exit points for this type of investment, unlike stock or bond investments that offer virtually immediate liquidity.


In times of crisis, liquidity is particularly sought after and there is no doubt that many hedge funds were unable to fully meet exit requests following the massive demand for redemptions at the end of 2008. They found themselves having to stagger redemptions, or sometimes even separate their illiquid investments from their more liquid assets into distinct classes (creating “side pockets”).


Recently, some funds have modified their structure or created a new, more liquid investment class so that they can offer investors better liquidity, usually weekly, and sometimes even daily.


Article 34 of the EU Directive on the Undertakings for Collective Investment in Transferable Securities (UCITS) imposes a minimum of fortnightly or monthly liquidity periods, which has the advantage for investors of reducing the terms of redemption.


This structure is particularly suitable for “long-short” strategies, which invest in more liquid assets than other types of strategy.


It is still too early to get an adequate performance history for these new, more liquid classes, but the performance targets announced by managers are clearly set lower than those of traditional, less liquid classes. There is a price to pay for reasonable liquidity with this type of investment.


Leverage certainly helps multiply gains by borrowing from banks several times the amounts managed, but it can also multiply losses. The existence of this leverage, however, confers considerable power to lenders, who can request redemption of all or part of the funds according to market conditions and the value of assets used as collateral for loans.


In the event of margin calls or demands for redemption, some hedge funds may be forced to sell assets or even to close the fund, as was, unfortunately, the case in 2008 with the Carlyle Capital and Peloton ABS funds, among others.


Using derivatives can also lead to a risk of significant losses on the fund's investments.

The lack of transparency linked with hedge funds can also represent a risk for investors, who are not always correctly informed about the strategies being used. This is often an opaque environment, and as Bing Liang of the University of Massachusetts showed in her study, “unfortunately, 35% of hedge funds produce misleading and unaudited data. 


If these small deviations from reality were taken into account, the average annual performance of hedge funds would no longer be 10.7% for the last few years (before 2004), but 6.4%.


A figure which pales in comparison to a performance of 6.9% for the stock market and 7.5% for bonds.” Moreover, dead hedge funds and those which choose not to reveal their performance are not included in hedge fund indexes, which are therefore biased.


In terms of performance, some studies show that compared to other financial assets (stocks, bonds, and real estate), this type of strategy may be less profitable over a longer period. For example, “from August 2003 to late 2008, the SPI index of Swiss stocks rose by 26.16% or 4.38% per year.


For this period, the CS Tremont Investable index shows a negative performance of −14.74% or −2.90% per year for hedge funds.” Nonetheless, this type of strategy resisted far better to the 2008 bear market, an exceptional year in every respect, where the magnitude of the correction that occurred in the markets was simply unforeseeable.


It is useful to note that hedge funds target positive performance above all, independently of any benchmark. This absolute return objective is certainly an interesting alternative to the traditional relative return approach.


Furthermore, it would obviously be a mistake to put all hedge funds in the same basket. There are excellent fund managers who are professional and competent, and who deliver satisfying performances independently of market movements.


Credit Suisse

We will leave it to each investor's discretion to decide whether or not they want to include hedge funds in their portfolio. However, it is essential to understand what we are investing in, how performance is delivered and the risks associated with the strategy concerned.


Unfortunately, the Madoff affair illustrated the lack of due diligence on behalf of certain banks and investment companies worldwide, who did not adequately question the way such a performance had been achieved over such a long period.


There are inherent risks in each particular strategy for hedge fund management, but these aspects do not fall within the scope of our analysis and we invite the reader to refer to specialized works in this area.


Malkiel recommends avoiding hedge funds, as in his view they were responsible for promoting the Internet bubble from 1998 to 2000 and for having played a destabilizing role in the oil market in 2005 and 2006.


He believes that the doubling in price cannot be explained simply by changes in supply and demand and it would seem that speculative activities, driven mainly by hedge funds, contributed to this rise.


In our opinion, it is more appropriate to consider this type of strategy as complementary to a particular asset class, while bearing in mind their illiquidity. For example, a long/short hedge fund should be considered in a portfolio's equity exposure because the fund's underlying assets are really just stocks.


A hedge fund using futures contracts on commodities should supplement exposure to commodities as they have the same underlying; only the type of strategy is different. The percentage invested depends on the investor and the share of funds that can be less liquid.


Structured Products Definition

By structured product, we mean “the combination of derivatives and traditional assets, such as stocks or bonds. The combination of these components results in a financial instrument in the form of security.” Structured products are usually divided into three categories:


1. Participation products, such as certificates, which accurately reflect the movement of the underlying asset.


2. Yield enhancement products, such as maximum-return products, that allow investors to forego the potential upside exposure to an underlying asset above a given threshold in exchange for compensation, in the form of either a discount or, as with a “reverse convertible”, an enhanced coupon.


These combine a bond with a short put option and at maturity either pay a high coupon, or the holder receives the securities according to the movement in the underlying.


3. Capital guaranteed products, which limit the risk of losses in the event of falling prices, while making it possible to participate in a rise in the underlying. Structured products can behave both like stocks and like interest-generating investments. Furthermore, the nature of the product can change dynamically over its entire lifetime.


Thus, investors keen to gain exposure to a specific market can do so in different ways. They can buy a few individual securities of companies listed on this market, buy an index fund for the market in question or buy into an investment fund. Finally, they can buy a structured product linked to the price movement of this underlying, depending on their views and price or return objectives.


Consequently, structured products are not really an asset class, but rather a particular form of investment in one of the asset classes according to the relevant underlying asset, investment theme or industry.


Their inclusion must depend on the terms of the issue of these products at the time they are being examined, and therefore on their attractiveness for investors.


Nonetheless, it is important to be conscious of the risks associated with investing in this type of product.


Future cash flows

In the case of government or other high-quality bonds, the future cash flow is known (all the coupons have to be paid); therefore, this market seems efficient. Moreover, it allows very little room for active management.


On the other hand, if we look at stocks, where cash flows are conditional, or commodities, where cash flows may even be non-existent, these markets are far less efficient and allow more room for active management.


So asset classes have differing degrees of efficiency, with differences within each class.


However, is it possible to exploit these inefficiencies by trying to forecast and anticipate prices? Is the modeling of market movements feasible?


We will attempt to answer these questions firstly by focusing on fundamental analysis, which seeks to determine the true value of an asset in order to compare it with the market price. We will then look at the technical analysis, which concentrates solely on the market price and its movements, and aims to take advantage of past information.


Both these approaches aim to exploit pockets of market inefficiency so that investors can determine an asset's “real” price compared to that established by the market, which is not really the “fair” price.


On the basis of these analyses, they can increase their chances of achieving their objective—capital preservation and growth—while reducing the risk of losses.