Understanding asset classes 

An asset class is a group of investments that share common features, including their potential for returns and their associated level of risk. All asset classes carry some risk.

Generally, assets with higher long-term growth potential are more likely to experience higher volatility – ups and downs in investment performance.

Asset classes and your investment

Asset classes form the foundations of any investment portfolio, including Mercer KiwiSaver scheme, Mercer Super Trust and Mercer FlexiSaver investment options. Knowing what to expect from each asset class can help you make investment decisions that are right for you.

Members of the Mercer KiwiSaver scheme, Mercer Super Trust and Mercer FlexiSaver, can choose from a range of investment options which may include a mix of some, or all, of the asset classes mentioned in this article.

• Shares – including New Zealand, Australian and International Shares
• Real assets – including unlisted property, listed and unlisted infrastructure
• Alternative assets – such as private equity and hedge funds
• Fixed interest – including government and corporate bonds
• Cash – including term deposits and bank bills

Top tip: Diversification - spreading your investments across a range of different asset classes and different assets within each class – can help reduce the risk of large short-term losses.

Shares

When an investor buys shares (also known as securities, equities or stocks) they buy part-ownership of a company. Listed shares can be bought and sold on an exchange, such as the New Zealand Stock Exchange (NZX) or the New York Stock Exchange (NYSE).

Shares typically provide investment returns from two sources; company profits (paid to shareholders as dividend income) and from fluctuations in share prices.

A share portfolio can be diversified by investing in companies of different sizes and from different industries. International shares can be further diversified by investing in different countries or regions. For example:

• New Zealand shares are listed on the NZX and include companies like Air New Zealand, Contact Energy and Fonterra.
• Australian shares are listed on the Australian Stock Exchange (ASX) and include companies like Woolworths, Telstra, CSL and the big four banks: Commonwealth Bank of Australia, Westpac, Australia and New Zealand Banking Group (ANZ) and National Australia Bank (NAB).
• International shares are listed on foreign stock exchanges like the NYSE or the NASDAQ. They could include companies like Microsoft, Amazon and Mastercard. They may also include stocks in companies from developed markets and emerging markets.

Top tip: Shares are normally included in a portfolio for their long-term growth potential. They can be volatile over the short term, so are generally considered a high-risk asset class.

Real assets: property and infrastructure

Real assets are tangible resources like commercial property and infrastructure assets. Real assets can be growth or defensive oriented and expected returns and associated risks can vary widely within the asset class.

• Commercial property – such as offices, shops, warehouses, and distribution centres can provide returns from both rental income and from growth in the value of the asset itself over time.
• Infrastructure – such as roads, railways, and airports are large assets that provide essential services. They can provide a steady stream of income, and the long-term nature of most infrastructure assets means their returns are less volatile. Infrastructure tends to contribute to a more defensive and diversified investment portfolio.

Top tip: Property investments are often included in a portfolio for their income generation potential.

Alternative assets

Alternative investments include assets not found in the other four asset classes. They cover a range of investment types including private equity, venture capital, renewable energy, hedge funds, and private debt.

Alternatives offer greater diversity to a portfolio because their performance can be less linked to the performance of the other four asset classes. That means they have the potential to perform well when markets are struggling and offset losses in other parts of the portfolio.

Fixed interest

A fixed interest asset is effectively a loan to governments or businesses. A bond, for example, is a loan from an investor to a government or business – the issuer.  The issuer promises to repay the loan at a certain point in the future, with interest payments along the way.

Fixed interest is regarded as a lower risk asset class and is usually included in a portfolio for relatively stable returns. Returns typically come from interest and changes to the market value of the bond. When interest rates rise, the value of a bond can fall. When interest rates decline, values can rise. Returns can also be impacted by the level of risk associated with the issuer.

There are different types of fixed interest assets such as government and corporate bonds.

Top tip: Alternatives can be growth or defensive assets and are generally included in a portfolio to increase diversification.

Cash
Cash includes term-deposits with banks as well as money market securities issued or guaranteed by a government, bank or corporate entity. Typically, cash investments offer lower returns than growth assets, in the form of interest.

Cash investments can be considered safer options, but gains may be eroded by inflation – when high inflation reduces the buying power of cash faster than the interest being earned. 

Top tip: Cash may be suited to those investing for a short time or those who want a very high level of security.

In summary

Asset classes are the building blocks of any investment portfolio. The risk and expected returns associated with any given investment option is dependent on the asset classes that underpin it. Understanding asset classes is an essential part of making informed decisions about which investment options are right for you.

^{This information has been prepared by Mercer (N.Z.) Limited for general information only. The information does not take into account your personal objectives, financial situation or needs. Before making any investment decision, you should take financial advice as to whether your intended action is appropriate in light of your particular investment needs, objectives and financial circumstances. Neither Mercer nor any related party accepts any responsibility for any inaccuracy. Past performance is no guarantee or indicator of future performance.}