Understanding Asset Class Relationships

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Understanding Asset Class Relationships

It’s called Intermarket analysis, and it is the study of how various asset classes interact with one another.

Excluding assets such as art or real-estate holdings, we have five major “financial market” assets classes:

  • Cash and cash equivalents, such as T-Bills or CDs
  • Fixed Income products such as bonds or Treasury notes
  • Currencies such as the US Dollar or British Pound
  • Commodities such as silver, coffee and lumber
  • Equities, trusts and ETFs trades on stock exchanges

There are several basic relationships between these asset classes which can be used for analysis, or to find trading opportunities.

During an inflationary economic period, like from the 1970’s to late 1990’s, you’ll typically see the following relationships:

  • Bonds and stocks move in the same direction, with bonds typically altering course before stocks.
  • Commodities and bonds/stocks move in the opposite direction, with commodities changing direction after stocks.
  • Commodities and US Dollar move in the opposite direction

These are general guidelines and over the short-term may not hold true. Also notice that bonds and stocks will often move together, but that bonds turn first. That means for some time bonds will be moving one direction while stocks move another. Also, since (bonds then) stocks turn before commodities, you may see periods where bonds, stocks and commodities are all moving the same direction.

Consumer and producer prices aren’t always rising though (inflationary period), economies also face deflationary times, and the relationships are different during such periods.

The relationships are the same except that stocks and bonds move in opposite direction. A deflationary period has been in place much of time since 1998 till now (2020), and stocks and bonds have for the most part been moving in opposite directions.

Here are the basic relationships in a deflationary period:

  • Bonds and stocks move in the opposite direction
  • Commodities and bonds move in the opposite direction
  • Commodities and stocks move in the same direction
  • Commodities and US Dollar move in the opposite direction

Figure 1 shows these relationships as they have played out since 1999 (click to enlarge).

At times these relationships are very clear and at other times they may seem disjointed. This is because all the markets are based on perceptions, which can change very quickly.

It is also important to note that we are not just looking at the major trends, but rather comparing peaks and troughs. From 2020 to 2020 it appears that stocks and bonds are both moving higher, and they are, but during the trend, when bonds are rising, stocks tend to decline, and when stocks rise bonds tend to decline. If two markets are supposed to move together, one could even be in a downtrend and one in an uptrend; it is how the waves of one asset compare to the waves of another. That said, if assets move together, generally they will move in the same direction.

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These concepts can also be applied to the cycle that all economies go through, which involves expanding and then contracting. This chart below is idealized; it reflects how assets act in a neutral market environment, without major inflationary or deflationary forces affecting assets.

Final Word

Even understanding a little bit about intermarket analysis can help you keep your wits about you in times of panic. Realize that money flows somewhere; when the sky is falling in one asset, that money is being diverted to another. The moves may not always be proportionate though.

Trading off this information can be difficult, since these are tendencies and in the short-term the relationships may break down. Also, there may be small periods of inflation or deflation within longer periods of deflation and inflation respectively.

By looking at the overall picture, you can generally see if something is askew though. For instance, in an inflationary environment when bonds and stocks have been rising together, and then bonds enter a downtrend while stocks are still rising, you should consider yourself alerted that the rally in stocks may also end soon.

Use intermarket analysis as a confirmation tool. You wouldn’t want to begin shorting stocks in mass until bonds have definitively turned lower, and stocks actually begin to trend lower as well.

Asset Class

What Is an Asset Class?

An asset class is a grouping of investments that exhibit similar characteristics and are subject to the same laws and regulations. Asset classes are made up of instruments which often behave similarly to one another in the marketplace. Historically, the three main asset classes have been equities (stocks), fixed income (bonds), and cash equivalent or money market instruments.   Currently, most investment professionals include real estate, commodities, futures, other financial derivatives, and even cryptocurrencies to the asset class mix. Investment assets include both tangible and intangible instruments which investors buy and sell for the purposes of generating additional income on either a short- or a long-term basis.

Asset Class

Key Takeaways

  • An asset class is a grouping of investments that exhibit similar characteristics and are subject to the same laws and regulations.
  • Equities (stocks), fixed Income (bonds), cash and cash equivalents, real estate, commodities, futures, and other financial derivatives are examples of asset classes.
  • There is usually very little correlation, and in some cases a negative correlation, between different asset classes.
  • Financial advisors focus on asset class as a way to help investors diversify their portfolio.

Understanding Asset Classes

Simply put, an asset class is a grouping of comparable financial securities. For example, IBM, MSFT, AAPL are a grouping of stocks. Asset classes and asset class categories are often mixed together. There is usually very little correlation, and in some cases a negative correlation, between different asset classes. This characteristic is integral to the field of investing.

Financial advisors view investment vehicles as asset class categories that are used for diversification purposes.   Each asset class is expected to reflect different risk and return investment characteristics and perform differently in any given market environment. Investors interested in maximizing return often do so by reducing portfolio risk through asset class diversification.

Financial advisors focus on asset class as a way to help investors diversify their portfolio. Different asset classes have different cash flows streams and varying degrees of risk. Investing in several different asset classes ensures a certain amount of diversity in investment selections. Diversification reduces risk and increases your probability of making a return.

Asset Class and Investing Strategy

Investors looking for alpha employ investment strategies focused on achieving alpha returns. Investment strategies can be tied to growth, value, income or a variety of other factors that help to identify and categorize investment options according to a specific set of criteria. Some analysts link criteria to performance and/or valuation metrics such as earnings-per-share growth (EPS) or the price-to-earnings (P/E) ratio. Other analysts are less concerned with performance and more concerned with the asset type or class. An investment in a particular asset class is an investment in an asset that exhibits a certain set of characteristics. As a result, investments in the same asset class tend to have similar cash flows.

Asset Class Types

Equities, or stocks; bonds, or fixed-income securities; cash, or marketable securities; and commodities are the most liquid asset classes and, therefore, the most quoted asset classes. There are also alternative asset classes, such as real estate, and valuable inventory, such as artwork, stamps and other tradable collectibles. Some analysts also refer to an investment in hedge funds, venture capital, crowdsourcing or cryptocurrencies as examples of alternative investments. That said, an asset’s illiquidity does not speak to its return potential; It only means it may take more time to find a buyer to convert the asset to cash.

What Is Asset Management?

A Basic Introduction to Asset Management Companies and How They Work

Asset management is the service, usually performed by a firm, of directing a client’s wealth or investment portfolio on their behalf. These firms typically have investment minimums, so their clients usually have a high net worth.

Understanding the field of asset management and what role asset management companies play will help you hire the right professional to meet your financial goals. You may even learn about money management options you didn’t know were available to you.

The Role of Asset Management Companies

Asset management companies take investor capital and put it to work in different investments, including stocks, bonds, real estate, master limited partnerships, and private equity. These companies handle investments according to an internally formulated investment mandate, or process. Many asset management companies offer their services to wealthy businesses and individuals because it can be difficult to offer services to smaller investors at an appropriate price. 

Wealthy investors typically have private accounts with asset management firms. They deposit cash into the account, in some cases with a third-party custodian, and the portfolio managers take care of the portfolio using a limited power of attorney.   

How Asset Management Firms Operate

Asset managers work with client portfolios by considering several variables, including the client’s unique circumstances, risks, and preferences. Portfolio managers select positions customized for the client’s income needs, tax circumstances, and liquidity expectations. They can even base decisions on the client’s moral and ethical values as well as personality.

High-end firms may cater to a client’s every whim, offering a bespoke experience. It’s not unusual for the relationship between investor and asset management firm to span generations as managed assets are transferred to heirs.

Asset Management Costs

Investment fees for asset management can range anywhere from a few basis points to a substantial percentage of the shared profits on performance-agreement accounts. These fees will depend on the specifics of the portfolio.     In other cases, firms charge a minimum annual fee, such as $5,000 or $10,000 per year.

Firms for Average Investors

Some asset management firms have re-tooled their businesses to increase their offerings and better serve smaller investors. Many of these companies create pooled structures such as mutual funds, index funds, or exchange-traded funds, which they can manage in a single centralized portfolio. Smaller investors can then invest directly in the fund or through an intermediary such as another investment advisor or financial planner.

Vanguard, one of the largest asset management companies in the world, focuses on lower- and middle-income investors whose asset balances might be too small for other institutions.   Vanguard’s median account balance was only $22,217 in 2020, meaning half of their clients had more than that, and half had less. 

Vanguard’s efforts make this service more accessible to clients who likely couldn’t cover the minimum fee at most private asset management groups. These clients don’t have complex investing needs; they might simply buy $3,000 worth of a Vanguard S&P 500 index fund and hold it for the long term. They don’t have enough wealth to worry about things such as asset placement. Neither do they need complex strategies such as exploiting tax-equivalent yield differentials on municipal bonds and corporate bonds.

Robo advisors such as Betterment or Wealthfront, which are low-cost online investing platforms that use algorithms to balance portfolios, are another option for average investors. 

Combination Firms

Some firms combine service offerings for both wealthy clients and investors with more average-sized portfolios. For example, J.P. Morgan has a private client division for its high-net-worth clients, while also sponsoring mutual funds and other pooled investments for regular investors, who likely invest through a retirement plan at work. 

Another company, Northern Trust, has a large asset management business but also owns a bank, trust company, and wealth management practice. 

Registered Investment Advisors

Firms legally known as Registered Investment Advisors (RIAs) provide advice to their clients but outsource the actual asset management to a third-party asset management group. They do this either through a negotiated private account or by having the client purchase the asset management company’s sponsored mutual funds, ETFs, or index funds. 

Many asset management firms also serve as RIAs, therefore functioning as both asset managers and as investment advisors or financial advisors.

In other words, in the same way that all heart surgeons are doctors but not all doctors are heart surgeons, most asset managers are investment advisors, but not all investment advisors are asset managers.

The Asset Allocation Model

Many large asset management firms end up hiring their own financial advisors, who don’t manage assets directly. These advisors take on clients and steer them into the asset management division’s products and services, perhaps using an asset allocation model from a software package or an internal firm asset allocation guideline.

To use Vanguard as an example again, it’s first and foremost an asset management company. However, recently the company’s moved into financial planning for investors with smaller capital amounts. The client pays Vanguard’s advisors a fee of 0.30% of assets under management for the service. 

These advisors invest the client’s money into Vanguard’s family of mutual funds, on which the asset management division charges its asset management fees. Vanguard also raises money for its asset management business by allowing independent investment advisors to have their clients invest in Vanguard’s funds through third-party brokerage and retirement accounts. Furthermore, Vanguard has a trust department that sets up various types of trusts for clients. 

Asset Management Companies and Specialization

Each asset management firm has its area of specialization. Some are generalists—usually large companies that design financial services or products they think investors will want and need. Some firms have a narrow focus, concentrating on one or a handful of areas, such as working with fellow long-term investors who believe in a value investing or passive investing approach.

Some firms only cater to wealthy clients through private accounts known as individually managed accounts, or with hedge funds. Some focus exclusively on launching mutual funds, and some build their practice around managing money for institutions or retirement plans, such as corporate pension plans.

Finally, some asset management companies provide their services to specific firms, such as managing assets for a property and casualty insurance company.

Possible Fee Structures

Pay attention to how different asset management companies and their managers receive compensation. Many different business models exist in the asset management world and not all of them are equally beneficial to the client. For example, for a mutual fund with a 5.75% sales load, that price comes right out of the investor’s pocket, and it pays the mutual fund salesmen or financial advisor for placing the client in that particular fund.

Meanwhile, the asset management business itself earns its annual management fee, which is taken out of the pooled structure. In cases of integrated firms where asset management is one of the businesses under the financial conglomerate’s umbrella, the asset management costs might be lower than you’d otherwise expect, but the firm makes money in other ways, such as charging transaction fees and commissions.

In another fee variation, firms may charge no upfront transaction fees or commissions but, instead, take higher fees on other products or services, which they then split between the advisor and the firm for its asset management services.

Finally, fee-only asset management groups are companies that only make money from management fees charged to the client, rather than commissions or charges related to specific products. Many investors feel this gives the firm more objectivity in choosing investment products and strategies strictly for the client’s benefit, rather than choosing products based on the amount of fees or commissions earned for the firm.

Asset Management Accounts

You may have heard of an asset management account, even if your banking institution doesn’t call itself an asset management company. These accounts are basically designed to be a hybrid, all-in-one account, combining checking, savings, and brokerage. You can deposit your money, earn interest on it, write checks when needed, buy shares of stock, invest in bonds, and acquire mutual funds and other securities all from one, centralized account. In many, but not all, cases, the account is actually managed by a portfolio manager of the institution.

Fees might run you between 1% and 2.75%, depending on your account balance, but you may receive other advantages that make the price worth your while.   For example, some banks offer less-common investing strategies, such as allowing you to create collateralized loans against securities in your asset management account at highly attractive rates. This could be useful if you found an outside investment opportunity that required immediate liquidity.

Sometimes firms will also bundle additional services, such as insurance policies, so you save money by purchasing more products from the same company.

The Balance does not provide tax, investment, or financial services and advice. The information is being presented without consideration of the investment objectives, risk tolerance or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk including the possible loss of principal.

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