This article discusses the characteristics of various asset classes and how The Family Office can help you invest across these asset classes.
What is an Asset Class?
Broadly speaking, an asset class is a collection of investment assets that exhibit similar traits that may include return potential, volatility, risk, liquidity, tenure, and behavior in different market environments.
Understanding the characteristics of each asset class will allow you to build a diversified portfolio of investments that suit your risk-return profile.
Types of Asset Classes
Traditional asset classes comprise stocks, bonds, and money market instruments. They can generally be converted into cash relatively quickly as they are publicly traded.
Alternative asset classes include illiquid strategies comprising real assets, private equity, private credit, liquid strategies comprising hedge funds and other liquid alternatives. Alternative assets cannot be converted into cash on short notice as they are not publicly traded.
The Family Office adopts the “Endowment Model” as a long-term investment approach. This non-traditional investment style is favored by most Ivy League universities. Instead of speculating on public market stocks, 75% of endowment portfolios seek gains in alternative assets, away from the traditional route. Clients who commit to this model can benefit from superior opportunities, exceptional diversification, and the illiquidity premium.
Traditional Asset Classes:
1. Stocks (equities)
Stocks, also known as shares or equities, represent the share of ownership of a public limited company. You can buy or sell stocks on a public stock exchange and profit from either a gain in the share price or the dividends paid by the company. Within this asset class, there are several subclasses based on unique characteristics such as size (e.g.: large-cap, small- and mid-cap equities), geography (emerging market equities), growth equities (companies with rapidly growing revenues and earnings, such as technology stocks), value stocks (companies that are valued below their fair price), and others.
2. Bonds (fixed income)
Bonds, also known as fixed-income investments, are publicly issued loans by a corporate or government entity. The asset class generates a defined return for investors determined by the creditworthiness of the borrower or issuer. Rating agencies such as Moody’s and S&P rate the creditworthiness of issuers and individual issues. To qualify for the minimum investment-grade rating (S&P BBB), the issuer must have an adequate capacity to meet financial commitments. Speculative-grade bonds, also known as high-yield or junk bonds, tend to be vulnerable to adverse business and financial and economic conditions.
3. Cash (cash and money market instruments)
Finally, cash refers to paper currency, short-term bank deposits, or money market funds which aim to provide a higher above bank deposits. Returns are the lowest amongst all asset classes, but the credit risk is minimal.
Alternative Asset Classes:
1. Real assets
Real assets are physical or tangible assets such as real estate and infrastructure. Investment strategies vary and so do their underlying risk and return. The safest is the core/core-plus strategy, which invests in existing, fully leased assets that generate a stable rental income with only light improvements needed to increase yields. The value-add strategy entails investing in properties with low occupancy or below-market rents and rehabilitating them to increase occupancy and rents. The opportunistic strategy involves buying land for development which is far riskier than the core or value-add strategy due to cost overruns, completion risk and the longer waiting period before income is generated, but promises substantially higher returns. Real assets also feature many sectors such as residential, office, industrial, hospitality, and retail, and subsectors such as student housing, senior housing, medical offices, and others.
2. Private equity
Unlike public equity, private equity entails the ownership of shares in a private company that is not publicly listed. Like all asset strategies, private equity strategies vary depending on the stage of development of a company. A buyout, for example, involves the acquisition of a mature company, while venture capital involves a young, rapidly growing company. Meanwhile, a growth equity investment may involve a company that is not large enough for a buyout or fast-growing enough for venture capital. An investment is typically held for three to six years, during which a value creation plan is implemented to improve revenues and profitability. Private equity investments may be exited through an IPO or a trade sale to other asset managers or strategic buyers.
3. Private credit
Private credit involves private or non-bank lending to corporates. Credit may be classified by its seniority in the capital structure (the order in which payments from available cash flow is paid), its claims over assets that serve as collateral, or a combination thereof. Senior debt is the least risky as it ranks first in the capital structure and receives debt service payments before junior creditors. Mezzanine debt is subordinated to senior debt and compensated with a higher interest rate. First-lien debt has a first claim on specific assets held as collateral, such as a mortgage. Second-lien holds a subordinated claim over the assets. If the collateral is liquidated, first-lien lenders get paid first. Distressed debt involves buying the debt of companies that are close to insolvency or bankruptcy at a discount and either convert it to equity through a restructuring or receive the proceeds from liquidating its assets that exceed the cost of the debt. Special-situations credit involves providing a flexible, customized credit solution to a borrower.
4. Hedge funds
Hedge funds are actively managed investments that use a wide range of strategies including long and short positions in publicly listed securities and derivatives or the use of borrowed money to enhance returns. A macro hedge fund, for example, may seek to profit from changes in macroeconomic variables, such as interest rates and currencies. An equity hedge fund may seek to buy equities that are priced below their fair value. A relative value hedge fund may look for inefficiencies in market prices. The strategies are literally countless.
5. Liquid alternatives
The liquid alternatives asset class includes mutual funds and exchange-traded funds (ETFs) that are publicly tradable. They comprise a basket of securities that represent an index or theme. The difference is that mutual funds are actively managed while ETFs are passively managed. Both products are cost-effective ways to achieve portfolio diversification.
How The Family Office Can Help
It is not easy for investors to navigate through the countless options in multiple asset classes. Our experienced financial advisors can guide you to the investment solution that is right for you. Since 2004, The Family Office has been the independent wealth manager of choice for more than 200 ultra-high-net-worth families and individuals, helping them preserve and grow wealth with diversified customized portfolios that include exclusive alternative investment opportunities from top-tier international asset managers.
Schedule an appointment today.