Asset Classes: List, Characteristics, Asset Allocation

This page explains the concept of asset class and its use in asset allocation and portfolio management. We will discuss the characteristics of individual asset classes, such as risk, return, liquidity or correlations, and how they relate to economic cycle.

Asset Class Definition and Examples

Asset class is a group of assets with similar characteristics, particularly in terms of risk, return, liquidity, and regulations.

Equities (stocks) and fixed income (bonds) are traditional asset class examples. There are significant differences between stocks and bonds (different asset classes), such as risk, how they are traded, how they pay income (coupons vs. dividends), or how they are regulated. At the same time, all stocks (assets within the same asset class) share similar characteristics, as do all bonds.

This does not mean that all assets within the same asset class are exactly the same (for example, some stocks are riskier or less liquid than others), but generally the differences within an asset class tend to be smaller than the differences between asset classes.

List of Asset Classes

There is no official, universally accepted list of asset classes.

You will find lists of 3, 4, 5, 7, 9, and other numbers of asset classes. The lists with fewer items usually group some asset classes together.

The three major, traditional asset classes are:

• Equities (stocks)
• Fixed income (bonds)
• Cash and cash equivalents

These three are included in virtually all lists. Traditional financial models often work with these three asset classes (or with stocks and cash only).

That said, there are many kinds of investable assets which don't fit in any of the tree major asset classes – such as commodities, real estate, or art. These are often referred to as alternative investments.

So, a more complete list of four asset classes is:

• Equities (stocks)
• Fixed income (bonds)
• Cash and cash equivalents
• Alternative investments

Many sources list individual types of alternative investments as separate asset classes. This is justified given their different risk, return, and other characteristics.

A "full" list of asset classes can include the following:

• Equities (stocks)
• Fixed income (bonds)
• Cash and cash equivalents
• Commodities
• Real estate
• Infrastructure
• Private equity
• Hedge funds
• Art and collectibles
• Insurance

Some newer lists also include crowdfunding and cryptocurrencies.

Some sources, including the Macroption website, also work with volatility as standalone asset class.

Asset Subclasses and Overlaps

There are several reasons why no unified asset class list exists:

Firstly, there are subclasses (also called sub-asset classes) with very different risk, return, liquidity, and other characteristics in almost every asset class. For example:

• Value vs. growth, or small-cap vs. large-cap stocks
• Government bonds and corporate bonds within the fixed income asset class
• Energy, agriculture, industrial metals, precious metals in commodities
• Land, residential and commercial real estate
• Early stage and late stage private equity

Secondly, there are overlaps. Some investments can be included in multiple asset classes. For example:

• There are good reasons to include gold mining stocks in either equities or commodities.
• A hedge fund that only invests in publicly traded stocks (and never shorts) is quite similar to a traditional stock mutual fund (equities asset class), but has other characteristics (such as liquidity and regulations) that justify its place in the alternative investments or hedge funds asset class.

You can identify other groups of investments which could possibly represent a standalone asset class. For instance, emerging markets. Although emerging market stocks normally belong to equities and emerging market bonds belong to fixed income, there are typical characteristics shared by all emerging market assets (such as greater political and macroeconomic risk or lower liquidity).

Bottom line: Main idea of the asset class concept is not exact rules or exact list. It is that some assets are more similar than others, and that you should consider these similarities and differences when constructing an investment portfolio.

Asset Class vs. Financial Instrument

Financial instruments like options, futures or ETFs are not considered asset classes, although part of the asset class definition (e.g. similar regulations) fits them.

Asset classes are about economic substance, not form.

Different Instruments, Same Asset Class

For example, stocks, stock options, stock index futures, stock index ETFs and stock mutual funds all belong to the equities asset class, because all represent equity exposure (ownership stake in one or more companies).

Similarly, the USO (crude oil) ETF and crude oil futures represent the same asset class, although they are different financial instruments.

Same Instrument, Different Asset Classes

The same instrument can represent different asset class exposures, depending on how it is used.

For instance, "directional" option strategies with high delta and low vega, such as deep in the money calls or bull call spreads, have characteristics of the equities asset class (if the options are on a stock), but "non-directional" option strategies with insignificant delta, but high gamma and vega, such as straddles, could be classified under a standalone volatility asset class, because their risk and return is very different from traditional stock investments.

It is not the financial instrument itself – it is the exposure it represents, or the exposure you create with it – that determines which asset class it belongs to.

Asset Class Characteristics

The following are typical characteristics of major asset classes in terms of risk, return, liquidity, diversification potential, and special features. Note that in each asset class you can find exceptions that prove the rule.

Equities (Stocks)

• Shares of ownership in publicly traded companies
• High return, high risk
• Return consists of capital gains (stock price growth) and income (dividends)
• Very sensitive to economic cycle
• Generally high liquidity and low transaction costs compared to other asset classes
• Subclasses: value vs. growth, small cap vs. large cap, by region, by sector

Fixed Income

• Debt – money owed by issuer or another entity
• Lower return, lower risk than equities (bondholders get paid before shareholders)
• Return consists of capital gains (bond price growth – if bought below par) and income (coupon payments)
• Sensitive to interest rates (and thereby monetary policy, inflation, and economic cycle)
• Also sensitive to issuer's ability to repay = credit risk (and thereby to economic cycle)
• Subclasses: by maturity, fixed vs. floating interest rate, government vs. corporate bonds, the latter further by sector, credit risk / rating

Cash and Cash Equivalents

• No risk, no return (above risk-free interest rate)
• Perfect liquidity

Commodities

• Subclasses: energy, agriculture, industrial metals, precious metals
• Generally high risk, lower return than equities
• Good for diversification and as inflation hedge
• Correlation to equities and sensitivity to economic cycle varies (highest for energy and industrial metals)
• Agricultural commodities subject to specific factors (weather)
• Often high seasonality of returns
• Storage costs and convenience yield
• Liquidity varies (futures and ETFs on popular commodities like gold and crude oil are most liquid)

Real Estate

• Generally lower risk and lower return than equities
• Leverage available in the form of mortgages
• Return consists of capital gains (price growth) and income (rent)
• Considered good inflation hedge (prices tend to rise with inflation)
• Low liquidity, high transaction costs, related administration and taxes
• Subclasses: land, residential, commercial
• Sensitivity to economic cycle and correlation to equities vary (high for commercial, lower for land)
• Location, location, location! (determines risk, return, liquidity)
• Maintenance cost
• Unique risks (e.g. environment)

Infrastructure

• Examples: roads, railways, airports, water/energy production, storage, and distribution
• Lower return and lower risk than equities
• Good inflation hedge
• Low correlation to equities, low sensitivity to economic cycle
• Many characteristics similar to real estate (inflation hedge, low liquidity, maintenance cost, location matters)
• Typically long time horizon

Private Equity

• Like equities, represents ownership stake in businesses
• Unlike equities not traded on public exchanges
• Returns similar and sometimes higher than public equities, but so is risk
• Lower liquidity
• Unlike public equities, lacks the immediate feedback in real time stock prices, which can lead to underestimating volatility / risk
• Due diligence harder but more important than with publicly traded equities
• Passive or active (influencing company management)
• Subclasses: venture capital (early vs. late stage), leveraged buyouts, distressed, some types close to real estate and corporate debt

Hedge Funds

• Diverse group that overlaps with many other asset classes
• Subclasses: equity directional (long only, long/short), corporate restructuring, relative value, macro, quant (and many sub-subclasses within these)
• Risk, return, correlation to equities, and sensitivity to market cycle varies, depending on style
• Lower liquidity – often lock-up periods, notice periods, redemption penalties
• Higher management and performance fees (the traditional "two and twenty" and its variations)

Art and Collectibles

• Very diverse and unique
• Often represents value other than purely financial to the holder
• Very low liquidity, non-transparent and inefficient markets
• Low correlation to equities and low sensitivity to economic cycle
• Inflation hedge
• Typically long time horizon

Insurance

• Main role is risk management and diversification
• Payoff subject to specific conditions
• Low correlation to other asset classes
• Non-normal return distribution – highly positive skewness and kurtosis

Asset Classes and Asset Allocation

The concept of asset classes goes hand-in-hand with asset allocation (deciding how much of different asset classes to include in a portfolio), and diversification (the idea that you can improve a portfolio's risk and return profile by including different asset classes, due to low correlation between them).

Risk and Return

The main reason for including most assets in a portfolio is their (expected) return – after all, we invest to make money. Return typically comes in the form of capital gains (price growth) and income (dividends, interest, rent etc.).

But return is closely related to risk. Generally, investments which promise a high return (like stocks or private equity) are also the riskiest. Conversely, safer investments like treasuries earn lower return.

In finance, risk means the possibility that actual return from an investment will be lower than expected (or even negative). Simply said, risk is the possibility of losing money, or not making as much as expected.

A useful property of risk is that different assets (or different asset classes) tend to lose money at different times.

Therefore, if we include different assets in a portfolio, the gains from some will offset the losses from others, and the combined portfolio risk will be much smaller than the sum of risks of individual assets.

How well this works depends on the correlation between assets in the portfolio.

Asset Class Correlations

Simply said, correlation is a measure of how closely two things move together, in the same direction. It can reach values from -1 to +1:

• +1 = perfect positive correlation = two assets move exactly the same
• 0 = no correlation = no relation
• -1 = perfect negative correlation = when one goes up, the other goes down and vice-versa

Not surprisingly, assets in the same asset class tend to be highly positively correlated, while correlations across asset classes are much lower (and sometimes negative).

For example:

• Most stocks from the same sector have correlations of +0.8 and higher (they move in the same direction almost all the time).
• Stocks from different sectors still tend to have positive correlations, although slightly lower (it depends on the particular sectors and stocks).
• Assets from different asset classes, such as treasury notes, gold, or VIX index futures, often have negative correlations to stocks – they gain when the stock market goes down and vice-versa.

Therefore, adding treasuries or gold reduces total risk of a stock portfolio much more than adding another stock.

An asset class can be an attractive investment even when its standalone risk and return profile is not as good, if its correlation to other investments is low. In such case, it is added to the portfolio not to enhance returns, but to reduce risk by diversification.

Commodities are good example of such asset class. On their own, they are very risky (their prices move a lot) and their return is quite low in the long-run, but they have low correlation to traditional asset classes like equities and fixed income, so adding just a small weight (e.g. 5%) of commodity exposure can significantly reduce risk in a stock and bond portfolio.

It is not that simple though.

Correlations between assets or asset classes are not constant. They change in time.

For example, airline stocks are usually highly negatively correlated to oil prices, because jet fuel represents significant portion of costs. But if you held a portfolio of airline stocks and oil in March 2020 as the coronavirus pandemic broke out, you would have lost a lot on both. Suddenly the correlation was almost +1 and the diversification didn't work.

Like returns, past correlations don't guarantee future correlations, and must be taken with a grain of salt.

Asset Class Liquidity

Besides risk and return, liquidity must also be considered when deciding asset allocation. It is more important for some investors than others, but generally higher liquidity is better, other things being equal.

The asset class with best liquidity is cash (liquidity is, after all, the ease of converting an asset to cash).

Other asset classes with good liquidity include the following:

• Equities (stocks)
• Fixed income (bonds)
• Commodities

There are assets with higher and lower liquidity within these asset classes, but generally, stocks, bonds and commodities are easiest to buy and sell.

The other asset classes are generally less liquid:

• Real estate
• Infrastructure
• Private equity
• Hedge funds
• Art and collectibles
• Insurance

That said, there are some liquid investment vehicles with exposure to these less liquid asset classes – for instance ETFs and REITs (real estate investment trusts).

Asset Classes and Economic Cycle

Much of the diversification potential of different asset classes arises from their different sensitivity to the general economy.

Most investors are concerned about two main macro risks:

• Economic slowdown or recession
• High inflation

Asset Classes that Do Well in a Recession

A recession means business profits decline and some companies make losses, or even go bankrupt. This results in lower dividends and lower stock prices. Equity investors lose money (that said, the stock market usually bottoms several months before the general economy).

Economic downturn also affects some fixed income investments (particularly riskier corporate bonds), but benefits others (short-term government bond prices go up, as central banks cut interest rates).

The effects on stocks and bonds have been thoroughly discussed in classical investment theory. What about the other asset classes?

Private equity is like public equity – recession is bad.

Real estate also does rather poorly in a recession, although the effect varies by type (commercial is more sensitive than land), location, and the nature of the recession. Leverage is often bigger problem than falling property prices themselves.

Infrastructure investments don't do particularly well in a recession, but they tend to at least lose less than equities and real estate.

The same applies to art and other illiquid assets – they lose less, or at least the losses are not as visible as on stocks, due to the illiquidity and lack of public market.

Other asset classes are a mixed bag.

Some commodities, like energy or industrial metals, can be heavily affected by a slowdown, while others are not. Gold is known to often do well when almost all other investments lose money and is therefore popular for diversification.

Hedge funds, being a diverse group, have mixed exposure to the economy. For instance, equity directional funds with net long exposure obviously lose money. Other styles, like macro or some trend following funds, benefit from the increased volatility and trading opportunities.

One effect a recession has on hedge funds is that it magnifies the variability within the asset class. Manager skill matters more when markets are volatile.

This is in fact true to all asset classes:

In a recession, differences between individual assets within the same class are much greater than in peaceful times.

This may not be true initially, especially if a recession or market crash is caused by a sudden shock (coronavirus comes to mind), but when the "dust settles" the winners start to diverge from the losers.

For example, at the beginning of a credit crisis, all banking stocks fall. But over time it becomes clearer which of the banks will be hit hard and which will do OK, and their stock prices start to reflect that.

Asset Classes that Do Well in High Inflation

High inflation is particularly bad for cash and fixed income – with one exception: inflation-protected bonds, such as TIPS (Treasury Inflation-Protected Securities).

The effect of inflation on equities is mixed, depending on sector and time horizon. In the long run, equities represent solid protection against inflation.

Some alternative assets are very effective as inflation hedge. In particular:

• Commodities
• Real estate
• Art and collectibles

One thing these have in common is that they represent hard, tangible assets.

Bottom line: A diversified portfolio of stocks with some alternative investments should do well in high inflation if your time horizon is long. If you are more conservative, inflation-protected bonds are the best inflation hedge.

Popular Questions about Asset Classes

What Are the Major Asset Classes?

The tree major, traditional asset classes are equities (stocks), fixed income (bonds) and cash.

Examples of other asset classes include real estate, commodities, private equity, art, or insurance.

See list of asset classes.

What Are the 5 (or 7 or 9) Asset Classes?

There is no unified, universally accepted list of asset classes. That said, the sources which list 5 asset classes usually include the following:

• Equities (stocks)
• Fixed income (bonds)
• Commodities
• Real estate
• Cash and cash equivalents

Other sources list additional asset classes, such as private equity, hedge funds, infrastructure, or art and collectibles. Some sources bundle these with real estate or commodities under a single asset class named alternative investments.

What Is the Best Asset Class to Invest in?

Because different investors have different risk tolerance, time horizon, liquidity requirements, and other needs, no single asset class is best for all investors under all circumstances. Furthermore, different asset classes tend to perform differently in different phases of the economic cycle.

For instance, equities (stocks) earn high return in the long run, but they can be volatile in the short run. Therefore, they are one of the best asset classes to invest in for a long-term investor, but less suitable for those with shorter time horizon and greater risk aversion.

It is often best to combine different asset classes in a portfolio. Depending on their correlations, multiple asset classes can significantly improve the risk and return profile of a portfolio. See Asset Classes and Asset Allocation.

Which Asset Class Is Least Risky?

Generally, cash and short-term treasuries are considered the least risky asset classes.

That said, they don't protect the investor against inflation. In high inflation, as the value of money declines over time, the purchasing power of the same cash amount goes down.

Assets which have both low general risk and do well in high inflation include inflation-protected bonds, such as TIPS (Treasury Inflation-Protected Securities).

Which Asset Class Is Most Risky?

Generally, equities (stocks), private equity and commodities are among the riskiest asset classes.

That said, subclasses or individual assets within the same asset class can have very different risk.

For example, a small or micro cap stock is usually much riskier than a large utility or telecom stock with long history of consistent profits and dividends.

Similarly, in private equity, a highly speculative early stage venture investment is riskier than a more mature company.

Even in asset classes generally considered less risky (like fixed income) you will find very risky subclasses and assets (such as high yield bonds).

Which Asset Class Has the Highest Liquidity?

The asset class with best liquidity is cash (liquidity is, after all, the ease of converting an asset to cash).

Other asset classes with good liquidity include the following:

• Equities (stocks)
• Fixed income (bonds)
• Commodities

Note that some assets within these asset classes are quite illiquid (such as some small cap stocks or some corporate bonds), and some assets from generally illiquid asset classes (like real estate) have good liquidity (such as some ETFs or REITs).

Are ETFs an Asset Class?

ETFs are financial instruments and not considered an asset class. ETFs exist on different asset classes, for example:

• Sector ETFs (like XLF) or country ETFs (like EWZ) belong to equities asset class.
• Bond ETFs (like TLT or LQD) belong to fixed income asset class.
• Commodity ETFs (like GLD or USO) belong to commodities asset class.

See difference between asset class and financial instrument.

Is Gold an Asset Class?

Gold is usually considered part of the commodities asset class, or its precious metals subclass.

That said, because the definition and classification of asset classes is not unified, some sources consider gold itself a standalone asset class.

One reason is that gold has a unique risk and return profile, which is very different even from other commodities, and it also has low correlation to most other assets.

Are Currencies / FX an Asset Class?

This is a complicated question, to which both professionals and academics give conflicting answers. There are arguments both for and against currencies being a standalone asset class.

A currency balance is cash, which is a widely recognized asset class. This would suggest currencies are part of cash and cash equivalents, and not a separate asset class.

That said, if we define asset class as a group of assets with similar characteristics (like risk, return, liquidity, or the way they trade), currencies fit this definition quite well – as long as we consider a currency an asset.

There are popular currency ETFs (such as FXE or FXY), based on the idea of investing in a currency as an asset.

In countries with unstable domestic currencies, many people hold part of their savings in dollars or euros.

There are dedicated currency trading desks in some firms, while others put forex under fixed income (that alone is not a strong argument – many institutions put commodities under fixed income too, and few people would consider commodities part of the fixed income asset class).

Generally, you can consider currencies either a subclass of the cash and cash equivalents asset class, or a standalone asset class.

Either approach has good reasons. There is no single "correct" asset class classification.

Are Options an Asset Class?

Options (and futures and other derivatives) are instrument types and usually not considered asset classes. Options exist on different asset classes: option on stocks, currencies, commodities etc.

That said, volatility (option strategies with significant vega exposure, or volatility products such as those linked to the VIX index) is sometimes considered an asset class.