4. asset classes

8/6/2019 4. Asset Classes

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Investment classes

Equity Real estate Precious Objects Commodities

Fixed Incomesecurities

Derivatives andstructured products


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Investors can keep their money in the formof fixed deposits with banks. These fixed ortime deposits offer a fixed rate of interest

for the entire period. This is the safestinstrument for someone looking for a modestrate of growth.


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Fixed-Income Securities are financial claimsissued by governments, governmentagencies, state governments, corporations,

municipalities, banks, and other financialintermediaries. These securities offer apredictable stream of payments by way ofinterest and repayment of principal at the

maturity of the instrument.


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Debt funds are mutual funds that invest indebt instruments. This is another way oftaking exposure in the debt markets.


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These schemes are meant to promote savingsamong masses. Such schemes are usuallyfloated by government or government

agencies. The rate of interest is less, butthen there are tax exemptions on interestearned.


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1. Investors benefit by investing in debt as theyreserve and increase their invested capital andensure the receipt of regular interest income.

2. Investors can even neutralize the default risk

on their investments by investing ingovernment securities. If the risk tolerancelevel of the investor is low, debt instrumentsmay suit the investment needs better.

3. The prices of debt securities display a loweraverage volatility as compared to the prices ofother financial securities and ensure greatersafety of accompanying investments.

4. Debt securities enable wide-based andefficient portfolio diversification and thusassist in portfolio risk mitigation.


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Interest rate risk

Reinvestment risk

Default risk


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This is the most risky asset class as equitycapital is permanent/non-redeemable capitaland the payment of dividends is also

discretionary. The return comes in the form of dividends

and through appreciation in the price of theshares.


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A. Dividends

B. Cash Dividends stock dividends and sharerepurchase

C. Capital GainsD. Right to subscribe to new shares

E. Right to vote

F.

Right to information


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A. Residual capital

B. Capital Losses

C. Liquidity Risk


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Stock Market classification of Equity Shares

Blue chip shares Shares of large, well established, as well as financially

strong companies with an impressive record of earningsand dividends

Income shares Such shares have stable operations, high dividend

payments, and relatively limited growth opportunities

Growth shares Shares of companies that have a fairly entrenched

position in a growing market. Such shares enjoy anabove average rate of growth as well as profitability.


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Cyclical shares

Shares of such companies that have apronounced cyclicality in their operations.

Speculative shares Shares that tend to fluctuate widely because

there is a lot of speculative trading in them.

Defensive shares

Shares of such companies are relativelyunaffected by the ups and downs in generalbusiness conditions.


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The investment decision-making process iscarried out while investing in the stocks inthree major ways:

Fundamental Analysis (what to buy) Technical Analysis (when to buy)

Quantitative Analysis (tools to be used)


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Top down approach studies the economicfactors like consumer demand, percentagechange in business investments, percentage

change in government expenditure, changesin net exports, change in inventories,inflation, unemployment, fiscal andmonetary policies.

Starting with the actual and potential outputgrowth in the economy, the factors thatdetermine the growth in a good portfolio areas below:


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Top-Down Approach:

Depending on the state of the economy, there can befour phases like:

A) Overheat (high growth, high inflation)

B) Soft landing (low growth, low inflation) C) Hard landing (low growth, high inflation) D) Recovery (high growth, low inflation)

For example, during soft landing, the stock market

outlook would be: Positives low interest rate, rising earnings Negatives uncertainty high Positive/subdued outlook for stock market cash

position is low


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Style:

Growth/large best during periods of fallingrates and sluggish economy

Current outlook positive for chosenlarge/growth style

Sector:

Defensive/growth best (cyclical/value worst)during periods of economic sluggishness(recovery)

Moving towards underweight consumer stocks


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Bottom-up approach:

This approach determines what stocks tobuy in each sector buy fear and sell greed.

The goal of stock analysis is to find theoutliers. Buy/sell stocks that will rise/fallmore than the industry and sector.


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Bottom-up Approach: Business factors include: A) Competition B) Product and markets C) Production and distribution D) Government regulation E) Labor F) Quality

G) Assets H) R&D i) Business Plan J) Management


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Financial Factors Include:

A) Growth rate B) Payout C) Financial leverage

D) Asset Utilization E) Margins F) Life Cycle Valuation factors include:

A) Time horizon B) Patience of investors C) Consensus expectations D) Trading E) Value Added F) Previous performance of stock


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As per the IAS, a derivative has the followingfeatures:

1) Its value changes in response to the

change in a specified interest rate, financialinstrument price, commodity price, foreignexchange rate, and such others.

It requires no initial net investment or an

initial net investment that is smaller thanwould be required for other types ofcontracts.

It is settled at a future date.


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Exchange Traded futures and options Future contracts are organized/standardized

contracts, which are traded on the exchanges.The terms like quantity, quality, standard time

delivery, place etc. are standardized by theexchange. Futures may be financial futures orcommodity futures.

Options are instruments whereby the right isgiven by the option seller to the option buyer tobuy or sell a specific asset at a specific price on

or before a specific date. Option Terminology Option buyer, Option seller,

Call Option, Put Option, American option,European option, Strike price/exercise price,Option premium.


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Factors Affecting Option prices

a) Spot Prices

b) Strike Price

c) Time to expiration

d) Volatility

e) Risk free rate of interest

f) Dividends

OTC or structured derivatives - FRAs


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Structured products are synthetic investmentinstruments. They are created to meet specificneeds that cannot be met from the standardizedfinancial instruments available in the market.

Structured products typically result in a financialproduct that is often non-standard andstructured to meet the specific financialobjectives of a customer.

There are usually two components for anystructured product: An at risk element which is called an alpha

generator, provides the high performancepotential. This alpha generator can be a stock, anindex, currencies, or commodities.

An element of capital protection, usually a bondproduct.


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The bond element sets the time horizon andthe level of capital protection offered by theproduct. The alpha generator provides the

enhanced performance potential. A lower risk, defensive structured product

will allocate the majority of the investorscapital to the bond element. A higher risk

aggressive product will use derivatives toincrease the extent of alpha exposure.


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Residential House

The total return (rental savings plus capitalappreciation) from a residential house is

satisfactory.Ownership of a residential property provides

psychological satisfaction.

Loans are available from various banks and

financial institutions for buying orconstruction of a residential property.

Interest on loans taken is tax deductiblewithin certain limits.


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Commercial Property

The more affluent class of investors may beinterested in investing in commercial

property. This investment fetches both agood rental value and enjoys capitalappreciation.


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Agricultural Property

Merits:

Agricultural income is not taxable.

Loans are available for agriculturaloperations at a concessional rate.

Agricultural land is exempted from wealthtax.

Capital gains arising from the sale ofagricultural land are not regarded as capitalassets or may be taxed at a concessionalrate.

There is a charm in living in a farmhouse.


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Demerits

In many states, land ceiling laws are quiterestrictive. In addition, law of some states

precludes non-agriculturist from acquiringagricultural land.

Farm houses in general are not safe.

Many states have laws that confer ownership

to the cultivating agent. Agricultural activity is often uneconomical or

not that profitable, particularly if done on apart time basis.


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Suburban Land

Land within city limits is often veryexpensive. Investors can buy residential land

(converted land) in private layouts insuburban areas at affordable prices. Suchinvestments enjoy high capital appreciation.


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Real Estate Investment Trust (REIT)

This class of investments not in existence inIndia. AMFI and SEBI have agreed to launch

Real Estate Mutual Fund Schemes as an initialstep.

REIT is common in the USA with over 190publicly traded REITs approved by SEC. REITs

offer a source of capital to realty firms. In UK, real estate investments are done

through pooled management vehicles (PMVs).


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Mutual fund is a mechanism for poolingresources by issuing units to investors andinvesting funds in securities,

Diversification reduces risk. Investors inproportion to their investments share theprofits or losses.


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Diversification

Professional Management

Liquidity

Convenience

Economies of scale


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Dilution

Fluctuating returns

Evaluating funds

Costs


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On the basis of maturity period

On the basis of investment objective

Growth/Equity-oriented scheme

Income/debt-oriented scheme

Balanced fund

Money market or liquid fund

Gilt funds Index funds

Equity-linked savings schemes

Load fund Vs. no-load fund


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The hedge fund industry has grown at anextraordinary pace in the last decade, from 300 fundsin 1990 to more than 9000 today. These funds havebecome highly visible in the markets and manage thecapital of around US$ 1.3 trillion.

Hedge fund is a private investment vehicle thataggregates the investments of several participants.

Hedge funds have very limited public transparency,high minimum investment, investors accreditationstandards, and incentive fees for the investmentmanager. The attraction of hedge funds is theirpotential to earn attractive returns irrespective ofthe direction of general market movements. Thus,hedge funds are also called absolute return funds.


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Role of Hedge Funds in portfolio construction

Since hedge funds are expected to provide a combination ofconsistently positive return stream and a low correlation to therest of the portfolio, the addition of this asset class to a standardequity-dominated risky portfolio should result in reducedvolatility with little or no diminution of expected return.

Investment strategies of Hedge Funds1. Long/short equity

2. Market-neutral

3. Event-driven

4. Convertible arbitrage

5. Short selling

6. Fixed-income arbitrage7. Managed futures

8. Global macro9. Equity trading

Market benefits of Hedge Funds


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The various types of commodities can becategorised as below:

a. Energy the commodities under this

category can be classified broadly intothree categories

i. Primary energy sources like coal, crude oil,natural gas and nuclear fuel.

ii. Secondary energy sources like electricity,refined oil products, diesel, petrol, LPG

iii. Half products such as petrochemicals,ethylene, and naptha which may be includedas commodities in a broader sense.


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b. Mineral ores ferrous metals like iron, castiron, steel, and steel products; non-ferrousmetals like aluminum, copper, lead, nickel,tin, zinc; precious metals like gold, silver,

platinum.c. Agricultural food products most commonly

agricultural products are cereals, wheat,and corn, beverages like tea, coffee and

cocoa; fruits like apple, dates, grapes,bananas, oranges; cotton, jute, wool;rubber and timber; seafood products likefish, shrimps, and crab meat


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Not an efficient Market

Traded products are differentiated. Artmarkets are often very thin with very few

works of art of a specific artist traded eachyear

Market transparency is low

Large differences in expertise between

buyers and sellers Low liquidity

Transaction costs are high.


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Indian is an emerging story in the global art market

Recognition across geographies: good in quality aswell as aesthetic appeal.

Highly undervalued: both in comparison with

emerging markets and developed economies Nearly 3000 art investors in India investing above 2

million in a year.

Indian art market is growing at 30-40% today asagainst the world art market that is growing at 3-4%.

Expected to become Rs.1,000 crore industry in thenext 5 years.

A close ended art fund called Yatra launched byEdelweiss capital.


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Very subjective in terms of quality andvaluation

No regulation, no recourse

Not very liquidHigh transaction costs

Authenticity of art works

Long term investment horizon

High maintenance costs Sustenance of artists

No intrinsic value

No accounting standardisation

4. asset classes

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