Key Takeaways:
- Subclasses are buckets of stocks, bonds, and assets underneath the primary asset classes that share further similarities
- Examples of subclasses include region, market capitalization, industry/sector/themes, and growth vs. value
- These subclasses are critical factors in developing an investment strategy because of diversification considerations
Now that you are familiar with the primary asset classes and the various advantages and disadvantages to each (see this article), the next step is to go a layer deeper and understand subclasses.
Experts have grouped different stocks, bonds, and assets into subclasses. These subclasses are categorized by specific characteristics that make them behave differently within the broader asset class.
Understanding subclasses is important because it’s a crucial consideration in diversifying a portfolio (diversification is one of the fundamental principles in modern investment strategies). Properly allocating dollars across asset classes (e.g., stocks, bonds, physical, cash) is the foundation of a portfolio. Diversifying within the primary asset classes by investing across subclasses further strengthens a portfolio.
The primary subclasses are listed below.
- Region. As the title suggests, asset classes can be broken down by the region the bucket represents. The major regions are the U.S., foreign developed (e.g., U.K., France, Spain, Germany, Japan, Korea), and foreign emerging (e.g., China, Taiwan, India, Indonesia). Specific countries are also their own subclasses. As you can imagine, companies in specific regions likely share similar business environments (i.e., regulations, policies, customers, geopolitical profiles).
- Market capitalization (i.e., size). Market capitalization is the company’s perceived value as determined by multiplying the price per share with the outstanding number of shares, and is a measure of size. This metric further categorizes stocks into large, mid, or small. The reason stocks are grouped by size is because similar-sized businesses share characteristics across considerations such as growth and risk.
- Industry, sectors, and themes. Companies within an industry, sector, or theme make up their own subclasses. They are bucketed together because businesses in the same sector are interconnected in various ways. They might compete with each other for customers, employees, partners, and other resources. They usually operate under similar regulations and policies and potentially have shared interests. These companies often are impacted by the same macro- and micro-trends. One of the reasons that it’s helpful to understand this subclass is because understanding the proportion of an investment portfolio by sectors can help identify the opportunities and risks associated with it.
- Growth vs. value. Growth and value are two different approaches to investing. Growth, as the word suggests, represents companies expected to grow faster than others. These companies are more growth-oriented, which may mean re-investing more of its earnings and taking more risks. Growth companies typically do not pay a dividend, are more volatile, and have greater potential for price appreciation. On the other hand, value companies typically operate proven, profitable business models that have consistently generated cash. Value stocks are viewed as less risky but have less potential for real price appreciation.
These four subclasses are the layers underneath the broad asset classes. They play a role in evaluating an investment strategy and serve as a way to diversify further a portfolio, which we will get to in the next article.
Disclaimer: The contents of this website is an opinion and is for information purposes only. It is not intended to be investment advice. Seek a duly licensed professional for investment advice.