A new asset class?

Recent media reports state that the SEBI is mulling a new asset class for investors that is positioned between mutual funds and portfolio management services (PMS). Is the market regulator introducing an asset class, or is it proposing a new investment product? In this article, we discuss two important investment concepts — asset class and strategies — and their relevance to your investment decisions.

Asset allocation is your most important investment decision. This refers to the proportion of savings you invest in different asset classes. Your asset allocation decision is more important than selecting products to invest in each asset class. Therefore, defining asset class is important.

An asset class refers to a group of securities that have similar characteristics. Stocks listed on the exchange are all driven by systematic, or market risk. Therefore, we can group all stocks together as an asset class called equity. Similarly, you can group all interest-bearing securities as bonds. At a macro level, you have traditional and alternative asset classes. The traditional asset class consists of equity, bonds, and arguably real estate. The alternative asset class includes commodities, antiques, and currency.

What about private equity and hedge funds? Private equity typically refers to investing in shares of unlisted companies. But equity (shares) is already classified as an asset class. It is true that private equity has some characteristics that are unavailable in public equity (listed stocks). That said, private equity is also priced using public equity metrics.

Also, private equity is another way of taking exposure to equity as an asset class. Therefore, it would be best to refer to private equity as an alternative strategy to investing in equity. A thumb rule to apply is that correlation between asset classes must be low in normal markets. Hedge funds are investment vehicles like mutual funds. SEBI’s proposal to introduce an investment product that fits between mutual funds and PMS is an investment vehicle — one that could invest in asset classes such as equity and bonds and their derivatives.

Conclusion

The term asset class is often used liberally. Its importance lies in how you structure your portfolio. Suppose you decide to allocate your savings 60 per cent to equity and 40 per cent to bonds. You could then choose to have your equity exposure in both public and private equities. Finally, you can decide to choose mutual funds, PMS, or the proposed product as an investment vehicle.

(The author offers training programmes for individuals to manage their personal investments)