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Understanding Risk and Return across Various Asset Classes

Prof. Kinjal Shethia

To understand the importance of risk and return across various asset classes, it is imperative to first understand the meaning of asset class and its types, the risk involved in investing in various asset classes and the returns generated by investing in it. Once all these key concepts are understood, then a relationship between risk and return can be established across various assets classes to get the insights of overall investments.

Asset class:

Asset class is a broad group of securities or investments that have similar characteristics and tend to react similarly in different market conditions. There are three main asset classes: equity securities), fixed income securities and cash equivalents (money market instruments). Real Estate, commodities, derivatives are also considered asset classes by some investment professionals.

Asset Allocation:

Asset allocation is a mixture of investments which comprises of these asset classes. The table below highlights different asset classes, its characteristics, the risk involved and nature of return.

Asset Class	Characteristics	Risk	Return
Equity Securities such as shares of publicly listed companies like RIL, Infosys, etc	Equities are the most volatile asset class, with such a high risk it has achieved highest return.	High	high
Fixed Income Securities Such as Government bonds, Corporate bonds etc.	Fixed income securities are less volatile than equities. Fixed amount of interest is received at regular interval along with the principal amount at the end of the set term.	Low/Moderate	Moderate
Cash Equivalents Such as CDs, T-bills, CPs, etc.	Lowest level of risk and return of all asset classes. The investment is for a short term perspective.	Low	Low

Choosing where to make investments greatly depend on many factors which includes the overall investment objectives, risk profile, expectations of returns, time period to invest, etc. Thus it becomes crucial to understand the risk-return across asset classes.

Risk:

One of the important types of risk involved during the process of asset allocation is the investment risk. Investment risk refers to the level of fluctuation or volatility in investment returns. Level of fluctuation or volatility (risk) in investment return could be Risk of losing initial investment, Risk of getting lower than expected return (growth rate) and Risk of getting lower than expected return in income.

Returns:

Different asset classes give different level of returns. The return could be low, moderate or high depending upon proportion of money diverted across different asset classes. Asset classes are divided into two categories of Defensive assets are long term investments which provide stable returns and Growth assets are investments which provide higher returns but returns are less stable.