An introduction to the main asset classes for ETF investors

justETF.com

Stock markets make all the headlines, but equities are not the only asset class – and ETFs enable you to construct a diversified portfolio of different kinds of assets more cheaply and easily than ever.

An introduction to the main asset classes for ETF investors When most people hear the word "investing" they immediately think of shares – or equities, to give them their fancier name.
 
But shares are just one of several asset classes that you should consider holding in your portfolio.
 
An asset class is a grouping of securities or investments that have similar characteristics and tend to behave the same way in different market or economic conditions.
 
Because of the differing characteristics of the various asset classes, when one is struggling, another may be delivering superior returns.
 
Ideally, the poor returns from one asset class over some particular period of time may be more than offset by gains from a different one.
 
By holding different asset classes in a portfolio, an investor can therefore aim to generate an acceptable overall return, with reduced volatility on the total money they have invested.

 

The main asset classes

There are five major asset classes to consider when building your ETF portfolio:
 
Cash – Familiar to everyone, cash is the most liquid asset, and the safest since it does not fluctuate with market pricing. However the returns are typically low for this reason, and may be negligible once inflation is taken into account.
 
Bonds – Bonds are loans made by investors in return for a fixed income stream over a specific period of time, and also the promise of getting your initial cash back at the end of the period. Once issued, bonds are freely traded, which means their day-to-day prices fluctuate.
 
Property – Commercial property (also known as real estate) such as offices and factories, where an investor gets an income stream derived from rent, plus capital gains as building and land becomes more valuable. (With ETFs you invest in collections of listed property companies, rather than directly into property).
 
Equities – Traded shares of stock market listed companies. Shares can deliver an income stream (via dividends) but unlike with bonds this is paid at the discretion of management. Investors also look for capital gains as companies (hopefully!) become more valuable over time. Over the long-term, equities in developed markets such as the UK and US have delivered the best returns, but at the cost of greater volatility – and the occasional stock market crash.
 
Commodities – Commodities are bulk goods such as gold, oil, and corn. In general, they are traded on their future prices and offered in ETFs as mixed baskets. Precious metals, as an exception, may also be bought at spot price through Exchange Traded Commodities (ETCs). In a multi asset portfolio, commodities generally are used to increase diversification and therewith lower risk. In addition, ETFs that offer commodity exposure are very popular with short-term traders taking a view on the markets.

 

Divide and conquer

These major asset classes can be broken down into further sub-categories.
 
For example:
  • Bonds can be divided into government bonds and corporate bonds.
  • Equities can be divided by country, by sector, by size, or in many other different ways.
And so on.
 
These subdivisions have their own characteristics of risk and reward, and may respond differently to others in the same asset class over the economic cycle.

 

An ETF for every asset class

ETFs are an excellent way to get exposure to these asset classes quickly and cost-effectively.
 
The table below shows the wide range of ETFs available, which covers all the main asset classes and many sub-categories.
 
You can find the right ETF for you using the search tools at justETF, and then simply buy via your broker.
 
Asset Class Number of ETFs Total AUM in m GBP
Equity 643 196,552
Bonds 169 82,875
Commodities 14 2,301
Real Estate 13 5,564
Money Market 10 2,400
Total 849 289,692
Source: justETF.com; As of 08/12/16