How different investment types play a role in market volatility
Understanding what the different types of investments are, and how they work, can help to explain why events like Coronavirus, may be impacting some peoples’ investment portfolios and super more than others.
In this article, we’ll break down what constitutes a growth verses defensive asset class and what the benefits are for each.
Asset classes perform differently
There are many different types of asset classes — shares and property, fixed income and cash are common ones.
Given how wide and varied they are, it’s unlikely that a single asset class will meet all of an investor’s needs. As such, an investment portfolio is likely to include a mixture of many.
As each asset class has its own characteristics, they perform differently at any point in time. So, when combined, they generate less volatility than simply investing in one, like shares.
Defensive versus growth asset classes
While asset classes differ, they also have some things in common. It’s these commonalities that helps to categorise them as either growth or defensive asset classes.
Understanding how much of a portfolio is invested in one verses the other, can help determine the sort of volatility and returns an investor might expect. Other factors include investment goals, timeframe for investment and comfort with market volatility.
Growth asset classes explained
Growth asset classes have the potential to provide investors with higher returns, over the long term, by increasing the value of an original investment.
Investment returns are more likely to fluctuate over a short period however, due to changes in the market and other economic factors as we’re seeing with Coronavirus. Common examples of growth assets are shares and property.
Shares are considered as a growth asset and aim to provide greater returns over a longer timeframe.
When invested in shares, an investor becomes a co-owner of the business - these could be household names like BHP, Telstra, and Amazon.
Returns from shares can be received in two ways:
an increase in the company’s share price which makes an original investment more valuable, and
dividends which are an investor’s share of the profits that the business makes.
On the flip side, share prices change daily so they present greater volatility and are considered higher risk.
Property is also considered a growth asset as its value has the potential to grow over time and is one of few investment types that’s tangible — something you can see, feel and touch.
Broadly, there are three main ways someone can invest in property.
Purchase of residential property can be as an owner-occupier, or investor. While less volatile than shares, residential property values can change depending on demand in the market and supply of properties. Unless an investment in property is via an investment fund, there are high costs involved to buy and maintain it.
Real Estate Investment Trusts
Real Estate Investment Trusts (REITs), trade on share markets, in the same way as shares do, and give investors access to commercial property, such as offices, retail shopping centres, and industrial property for example.
REITs operate like managed funds with professional investment managers. They combine the money of many investors to purchase properties. Investors then earn distributions from REITs and can also benefit from long-term price increases.
Unlisted Property Trusts
Finally, there are Unlisted Property Trusts, which can also give access to properties through a trust, similarly to REITs. However, unlike REITs, these investment vehicles are not traded on stock exchanges. When buying into an Unlisted Property Trust, an investor essentially buys a ‘unit’ in a Trust that holds the properties and the Trust is managed by an investment manager.
The initial amount invested stays within the Unlisted Property Trust until individual assets are sold. The value of these units may go up and down and an investor may also have the right to receive income.
It’s important to be aware that Unlisted Property Trusts are ‘illiquid’, which means that it can be difficult to get money out when you want to. During a market crisis this can be very difficult — many investors found their funds became ‘frozen’ in Unlisted Property Trusts during the 2008/09 Global Financial Crisis.
Defensive asset classes explained
Defensive asset classes aim to provide investors with regular income. This helps to keep their values stable which means they have relatively low volatility or risk.
The downside to this safety is that over the long term, defensive asset classes usually deliver lower returns than growth asset classes. In addition, those returns may not be enough to protect an investor from the rising cost of living.
Cash is regarded as a defensive asset class given it generally doesn’t rise in value by much. It’s also considered to be one of the safest asset classes as it’s unlikely that an investor will lose money.
An investment in cash can be via a bank savings account or a short maturity term deposit, for example.
The best-known type of fixed income investments are bonds. They are considered part of the defensive asset cluster as they usually have lower risk than shares or property.
When investing in bonds you’re essentially lending money to a government agency, if it’s a government bond, or to a business in the case of corporate bonds.
With a bond, returns come in the form of the interest received from the loan. When there are changes in interest rates, the value of the bond changes too. For example, when interest rates rise, bonds with lower interest rates are less appealing to investors so their value tends to fall. On the flip side, when interest rates fall, their values tend to rise.
Bottom line: having exposure to a combination of defensive and growth asset classes in an investment portfolio, may help balance out risk and return. This is important to keep in mind when during times of heightened market volatility — defensive assets can help to cushion falls from growth assets.
Important information and disclaimer
This article has been prepared by NULIS Nominees (Australia) Limited ABN 80 008 515 633 AFSL 236465 (NULIS) as trustee of the MLC Super Fund ABN 70 732 426 024. The information in this article is current as at April 2020 and may be subject to change. This information may constitute general advice. The information in this article is factual in nature and does not take into account your objectives, financial situation or needs. You should consider obtaining independent advice before making any financial decisions based on this information. You should not rely on this article to determine your personal tax obligations. Please consult a registered tax agent for this purpose. An investment with NULIS is not a deposit with, or liability of, and is not guaranteed by NAB or other members of the NAB Group. Opinions constitute our judgement at the time of issue. In some cases information has been provided to us by third parties and while that information is believed to be accurate and reliable, its accuracy is not guaranteed in any way. Subject to terms implied by law and which cannot be excluded, neither NULIS nor any member of the NAB Group accept responsibility for any loss or liability incurred by you in respect of any error, omission or misrepresentation in the information in this communication. Past performance is not a reliable indicator of future performance. The value of an investment may rise or fall with the changes in the market.