Characteristics of Investments
What Is an Investment?
Buying an asset with the intention of selling it at a profit and/or holding it for the long-term to receive regular income is called an investment. There are various forms of investments that are generally split into two categories – public and private. By public, it means that they are traded at a regulated exchange such as the New York Stock Exchange (NYES) or the London Stock Exchange (LSE). Private investments such as private equity or private credit are not traded at an exchange and would typically require large initial investment and would only allow qualified investors in. Whereas public investments are popular both among individual and institutional investors, the private markets space is almost exclusively available to institutions only.
Key Learning Points
- Investments involve purchasing and selling assets with the aim of making a profit, holding them for the long-term to receive income or preserving wealth
- There are two ways to invest – directly or through and investment product such as mutual funds or ETFs
- It is important that investors consider multiple asset classes such as equities, bonds and property when constructing their portfolio
- Lower correlation between the different constituents in the portfolio is key for diversification, which over time could lead to better risk-adjusted returns
Types of Investments
The types of investment available to investors come in two forms – direct and through collectives.
Direct
Direct investing involves investors purchasing the securities (for example buying equities through an exchange) or assets (such as physical property) themselves and being responsible for the ongoing management of those assets. To do this efficiently, investors would need a lot of time and having expert knowledge, but eventually this could be a cheaper option since there are no management or performance fees charged.
Collective
By investing through a collective investment scheme, investors delegate their funds to an investment manager (for example, BlackRock) to manage them in their best interest. While they won’t have a say in the management of the funds, the decisions are made by a professional money manager who is typically supported by a large pool of experts that constantly research the market to come up with best investment ideas. In exchange, investment firms charge a fee for the management of the client’s money (usually lower for passive and higher for active management) and may also apply a performance fee. In terms of liquidity, depending on the structure of the investment, investors can either purchase or redeem their stake. Below are some examples of a collective investment scheme.
- Mutual Funds – these are products that provide daily pricing and trading (meaning can be purchased or sold once a day at their Net Asset Value). Mutual funds can invest in a wide variety of securities and asset classes and are the most common structure for active managers
- Exchange Traded Funds (ETFs) – unlike mutual funds, ETFs are “exchange-traded” and can be bought or sold intraday at different prices. They are passive investments that aim to closely replicate the performance of a benchmark such as market index (for example, the S&P 500)
- Investment Trusts – these are closed-ended investment companies that trade during market hours such as individual stocks. In their nature, investment trusts are identical to mutual funds and seek to deliver returns by investing in a basket of securities
- Hedge Funds – being a sophisticated investment product, hedge funds are only available to select group of clients such as high net worth individuals or institutions. They use complex strategies to deliver optimal returns and usually have lower correlation with traditional asset classes. Hedge funds are typically illiquid investments and may offer various purchasing or redemption periods, for example annually or every three years
The below chart shows the relationship between the different parties when investing in a fund.
Types of Investments in Security Analysis and Portfolio Management
There are various types and forms of investments that are categorised into different asset classes. Although the investments in each asset class as a whole are expected to share identical characteristics and performance pattern, investors should be aware that there are also various subdivisions and this may not be always the case. For example, large cap US equities may behave differently to their small cap peers in different market environments. In addition, each type of investment has its own risk and liquidity features, and potential for returns. Below we list the major asset classes.
Equity
There are generally two types of equity investments:
- Public equities – also known as “stocks”, these securities represent shares of ownership in a company that is traded on an exchange. Returns can be achieved in the form of capital growth and/or income though dividends.
- Private equity – an alternative form of investment in which an investors buys shares in a privately owned company (i.e. not traded at an exchange). It is an illiquid investment meaning that investors won’t have access to their funds for a specific period and should commit capital for the long-term.
Fixed Income
Fixed income, these are debt securities issued by governments (sovereigns), corporations and/or municipalities. They return the initial investment (principal) at maturity (i.e. the expiry date) and some of them such as bonds also offer interest payments (known as coupons)
Cash and Cash Equivalents
Cash and Cash Equivalents is considered to be the lowest risk type of investment. Cash equivalents include the likes of Certificates of Deposit (time deposits with fixed interest rates and maturity date) and Money Market Funds
Property
Property includes residential, commercial or industrial real estate, and aims to deliver returns through rental income or capital appreciation (i.e. the increase in the asset’s price over time)
Commodities
Commodities, as the name suggests, these are physical items like such as precious metals (gold, silver etc.), fossil fuels such as oil and gas, coal, agricultural products and so on. Investors would typically get access to trading commodities directly or through derivatives (primarily futures contracts)
Alternatives
Alternatives is a diverse group of investments that include private companies investing as well as exotic assets such as art, wine, luxury items (for example watches or jewellery), antiques and many more
Characteristics and Objectives of Investment Management
Investment management is the process of professionally administering the client’s funds by allocating them to various securities and assets in order to achieve their financial goals. Clients would benefit from the expert knowledge of the manager, along with more efficient trading through economies of scale. During that process, there are fundamental characteristics of each investment that need to be considered against the profile of the investor. Below is a list of some of these key characteristics.
In the free download section, we provide more context of the difference between saving, investing, speculating and gambling.
Examples of Investment Objectives and Basic Types
Different investors may have numerous objectives, and it is therefore essential that financial goals are considered on an individual basis and risk levels are carefully examined. Below are three broader examples of investment objectives.
Capital Preservation
Capital Preservation focuses on protecting the principal (the original amount invested) from losses. Capital preservation strategies aim to minimise risk rather than seeking sizeable returns and it is popular with risk averse investors. Suitable asset classes may include money market funds, high quality bonds and in some cases quality large cap stocks
Income
Income, as the name suggests, this investment objective aims to generate a stable income stream that is usually received in the form of interest or dividends. It favours regular income over capital growth and is often preferred by retirees. Suitable investments include bonds, dividend paying stocks and property
Capital Appreciation
Capital Appreciation as an objective aims to increase the value of the principal amount invested over time. It involves buying assets which value is likely rise in the future and selling them at a profit. This strategy is typically pursued by those with a longer investment horizon and a higher risk tolerance. Small cap equities or venture capital investment are typical for this type of investors
Conclusion
Investments can have different objectives such as capital growth or income (or both), and achieving these objectives involves purchasing different assets such as growth or dividend stocks. The various aspects that making an investment involves such as assessing risk tolerance and the investor’s tax position should always be carefully considered.