Investment Attraction: An Asset Class Framework for Designing Investments

With budget short falls and the need to create jobs, investment attraction has become a top priority for governments. The private sector is increasingly being called upon to pay for and lead investments into a whole range of assets; as well as solve social and environmental problems. However, finding the right investor and structuring the investment can be a challenging task. Understanding investment asset classes and the investor’s requirements in each category is a critical first step.

 Investors

It is important to note that an investor that that works in one class/sub-class may not work in another and each investor’s preferences will differ. As Chen (2019) notes, investors “are not a uniform bunch”.

Investor is any individual or entity “(such as a firm or mutual fund) who commits capital with the expectation of receiving financial returns” through income or capital appreciation (Business Dictionary, N.D; Chen, 2019).

Investors use their capital for long-term gain and therefore are different to traders who seeks to generate short-term profits by repeatedly buying and selling stocks (Chen, 2019). In addition, some investors will also try to address a social or environmental need as well as make a financial return. This is an exponentially growing[1] field called impact investment.

Impact investment is investment that aims to achieve positive and measurable social or environmental impact, as well as financial return (Impact Investing Australia, N.D; OECD, 2015).

In order to select and commence negotiations with potential investors, investment opportunities need to be analysed and matched with investors based on asset class, risk, capital requirements, involvement and timeframes amongst many other factors (Chen, 2019; Nerd Wallet, 2012). Thus, before designing investments or approaching investors, it is critical to understand the major groupings of investments.

What is an Asset Class?

Asset classes provide a framework to categorise and analyse an investment opportunity, structure the investment and match it with interested investors. Asset classes perform either a growth or defensive strategy in an investment portfolio, depending on the underlying economic conditions at any given time. Most investors will have a mix of investments but will not invest across the spectrum of assets or sub-asset classes (Citi, 2016; Chen, 2018).

Asset class is a group of comparable investments that are grouped together based on having a similar financial structure and are traded in the same financial markets, subject to the same rules and regulations (CFI, 2019).

Sub-asset classes are segments that are grouped by more specific characteristics factors such as similar capital allocation, risk and return ratios.  For example, the asset class equity refers to an investment in a business. However, the equity ‘spectrum’ includes shares on the stock market, start-up funds (~$20,000), venture capital (~$2-5M) through to mergers and acquisitions (over $20M). In addition, risk and return and management structure of each investment are all very different (Feld and Mendelson, 2011).

Explaining Each Asset Classes

It can be hard to classify some investments into asset classes. For example, you can invest in commodities through a company on the stock market that produces commodities, purchase tangible commodities or purchase commodity derivatives such as futures or options. Another example is real estate investment trusts (REIT) that are held as equity (Equity REITS) or fixed income assets (mortgage REITs) despite both being derivative of real estate (CFI, 2019).  Additionally, there are always new segments such as venture capital and crypto-currencies (Chen, 2018). However, it is typically agreed that there are five main categories: cash, equities, fixed income, infrastructure and real estate and commodities. A final sixth category, alternatives, is used to reflect non-traditional investments (Frankenfield, 2019). Thus, general asset classes are as follows:

Asset Class Framework

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  1. Cash and cash equivalents: refers to money or other liquid assets that can be a medium of exchange or mechanisms for payment. The main benefit for cash investors is safety as it is typically the safest form of investment. However, inflation and low interest rates can undermine the value of the asset (Frankenfield, 2019; Nerd Wallet, 2012).
  2. Equities: refers to ownership into a business and includes every things from traditional shares, trust structures, angel and venture capital. It is important to look at the capitalization, growth requirements, value and management structures when designing or investing in equities (Frankenfield, 2019; Chen, 2018; Nerd Wallet, 2012).
  3. Fixed Income: refers to lending money to a company or government for interest such as loans (debt), bonds, and certificates of deposits. While fixed income is similar to cash in that it tends to be a low risk-low return investment, it is also classified by the investment duration and credit rating (Frankenfield, 2019; Chen, 2018).
  4. Infrastructure and Real Estate: refers to property (i.e. bricks and mortar) where a return is made on the increased value or rental income generated. Infrastructure and real-estate may also be invested in when it helps to increase the value of other asset classes along that support supply chain development such as commodities (Frankenfield, 2019; Nerd Wallet, 2012).
  5. Commodities: are tangible natural resource commodities that have an end use. For example agricultural products such as grain or metals such as gold (Nerd Wallet, 2012).
  6. Alternatives: are investments that do not conform to the traditional financial securities including stocks, bonds or certificates.  While other asset classes such as real estate and commodities are sometimes added into this category, they should be separated as they have their own unique features.   Alternative assets therefore fall into two broad categories:
    • things people collect such as art and antiques that are regarded as having value to the investor. This sub-classes tends to be illiquid and value can be hard to determine; and
    • high finance such as private equity or hedge funds that give investors exposure a whole range of asset classes to balance risk (Chen, 2019; Zurich, 2019).

Why is it important to understand asset classes for investment attraction?

Understanding asset and sub asset classes allows governments and businesses to become more targeted in how they design investments and investors they engage with.  The following offers a list of preliminary questions to help design and attract investment opportunities:

 Investment design

  • How does the investor exit the investment?
  • How is the investment structured?
  • What are the standard industry/regulation terms?
  • How is the market performing overall in the asset class?
  • Where is the investment located?
  • what markets to you want to enter/expand into?
  • Are there any social or environmental goals associated with the investment?
  • What is the time horizon for the investment?
  • What time frame is the investor interested in?
  • Are there any tax advantages to the investment?
  • Is there a diversification element to the investment?

 Asset classification

  • Which asset class is the investment in?
  • Can it be classified into a sub asset?
  • What is the risk?
  • How liquid is the investment?
  • What is the reward? i.e. valuation metrics such as earnings-per-share growth (EPS) or the price-to-earnings (P/E) ratio or growth – market size?
  • What is the market capitalisation (how big is the firm and its tradeable stock)
  • Is there an income stream?

 Investor classification

  • Who invests in this asset /sub asset class?
  • Is the investor local, domestic or international based?
  • What scale of investment do they offer?
  • What other benefits does the investor bring? E.g. market assess/market knowledge/ growth knowledge
  • What level of involvement do you want an investor to have /do they want active or passive?

[1] In 2018 impact investment was worth six billion dollars in Australia (Uribe, 2018).

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