Let's have a look at some of the traditional asset classes. There are many ways to look at asset classes, but the three main traditional asset classes are equity, fixed income, and cash Equity is an asset class that includes investments in the shares of a company and represents partial ownership of that company. Investors generate returns from either receiving dividends from a company or from increases in the company's share price. In terms of risk and return, equities are typically riskier than the other traditional asset classes, but equity also generates a higher return on average than those other traditional asset classes. In terms of liquidity, equity can be highly liquid if the shares are listed on a stock exchange, but if the company isn't listed, it might be a bit challenging to find a buyer for your shares. Fixed income investments, also known as bonds, represent a debt liability from the issuer of the product, which could be a company or a government. Issuing a bond is similar to taking out a bank loan because they have a fixed maturity date on which the debt needs to be repaid. The amount of money to be repaid is referred to as the principle or power value of the bond. The returns on bonds are generated from fixed interest payments, which are referred to as coupons, but can also come from capital gains or losses if the bond is sold before its maturity date. In terms of risk and return, bonds historically generated lower returns than equity, but also have less risk. Since the coupon cash flows, unlike dividends are fixed, guaranteed cash payments. Also, there is a fixed maturity date when the principle will be repaid. The liquidity of bonds is typically quite low since many investors such as pension funds, for example, buy bonds with the intention of holding them all the way until maturity to pick up the fixed interest coupon payment. The exception here is government bonds, which can have very high levels of liquidity. Finally, the asset class of cash refers to deposits held within banks, but can also include investments in money market funds, or direct investments in money market products such as treasury bills or commercial paper. Cash products typically have very low risk, but also have relatively low returns in terms of liquidity, instant access, cash deposits, and money market fund investments are very liquid, but term deposits where the money is deposited for a fixed time period are less liquid within the cash asset class returns are generated Exclusively from interest. It is also possible to further subdivide these asset classes into more narrowly defined asset classes. For example, within equity distinctions can be made based on geography such as domestic versus international equities. Industry sectors, for example, energy versus financials or styles such as growth or value investing. For fixed income distinctions could be made in terms of government and corporate bonds or by credit rating such as investment grade and high yield bonds. This is a correlation matrix which plots the correlation coefficient, which ranges between positive one and negative one between different asset classes. This diagram covers a 10 year period from 2009 to 2019, and it demonstrates that over this period there was a negative correlation between US large equities and government bonds, suggesting that holding government bonds and US equities in a portfolio would provide good diversification benefits. On the other hand, there was a high correlation between US large equity, foreign large equity, and high yield bonds, meaning that holding these asset classes will not deliver the same level of diversification. At the bottom. Money markets equivalent to the cash asset class had low correlations to all other asset classes.
