An asset class is a category of financial instruments which tend to react similarly in different market conditions and which adhere to the same rules and regulations. The principal asset classes are cash, equities (including listed, unlisted, domestic, and foreign) which are securities linked to the capital of the issuing company, bonds, which are debt securities from the issuer (such as government and corporate bonds), commodities (e.g. precious and heavy metals, agricultural commodities and energy), derivatives (including swaps, options and futures), as well as real estate and collectors’ items, for example, artworks, precious coins, wine and stamps.
Every asset class offers its own risk and return outlooks. Historically, equities tend to offer better capital value potential than bonds, but at a higher relative level of risk. Cash has a weaker return expectation, but it ensures liquidity and protects the initial investment. In modern investment theory, a portfolio diversified across uncorrelated asset classes offers higher return outlooks for a level of risk that is lower than that of a less diversified portfolio. Asset allocation is the process that enables the weighting of each asset class within the portfolio to be optimised according to an investor’s expectations and risk tolerance.