Investment strategy: Selection of asset classes

The decision as to which asset classes are taken into account when putting together an investment strategy is of absolutely central importance. First some semantics: the terms “asset class” and “investment category” are used synonymously. However, both terms are abstract in nature: the term “Swiss equities” neither specifies which investment instruments and weightings should be used nor does it provide a measurable investment return. An asset class only becomes economically tangible through the allocation of a benchmark index. An index contains a concrete investment instruction specifying which securities are purchased and with what weighting and delivers a measurable performance. Choosing an asset class therefore inevitably requires specifying the associated benchmark index.

For investors it is therefore worthwhile to examine the construction principles of the associated benchmark for each asset class. On Economico we have prepared a factsheet with useful information for each index.

The Economico standard strategies manage with just five asset classes. In the Augur forecasting application, which we introduced in Flash 17, more than 90 different asset classes are currently maintained. How can one go from so few to so many asset classes (and vice versa)?

• Aggregation level: The number of asset classes depends heavily on the level of aggregation chosen. The global equities asset class can be represented by assigning a global market index (typically the MSCI World Developed Markets). Alternatively, one can break it down into regions or even individual countries and treat them as separate asset classes. This is just one of many classification options that directly influence the number of resulting asset classes.
• Consideration of niche segments: The financial industry constantly invents new asset classes such as hedge funds, private equity, commodities, microcredit or cryptocurrencies. This is not entirely without self-interest, as implementing such niche segments usually generates higher margins than standard categories.

A more detailed breakdown of an investment strategy – as possible in Economico through the specification of an individual strategy – makes sense if you have clear preferences or investment views regarding specific subcategories. In all other cases, investors are best served with a small number of broadly defined asset classes because only few strategies empirically outperform this simple structure and because it can be implemented in a transparent and cost-efficient way.