We can now finally look at the three types of investment and the two asset classes. We cover the different types of investment and outline the advantages and risks of each.
What is an investment?
Many people make investments, some without realising it. For example, people buy endowment policies ('with profits') or unit trusts and contribute to pension schemes. In all of these the pool of investments is shared for the benefit of those who have contributed, and sometimes their dependants.
Most shared investments, such as unit or investment trusts and insurance company products are, indirectly, investments in assets of various types. Some smaller pension funds are also indirectly invested (generally through managed funds), as are most Individual Savings Accounts (ISAs). Larger pension funds, and some (usually called self select) ISAs and PEPs may be invested directly in these assets.
DC Pension Fund investment options
DC schemes offer a range of different investment funds designed to invest a member’s money in different ways over the years until retirement. The member should choose a fund that offers the broad investment strategy they want and then all the details – such as the choice of the specific assets that the fund invests in – are handled by the particular fund’s investment experts.
Investment funds usually invest in a number of key categories of asset, including shares, bonds and cash. The choice of funds will cover ones that specialise in specific assets – eg a fund focusing on shares in European companies - or ones that invest in a mix of different assets – eg a fund investing in both global shares and government bonds.
Most people choose to invest their pension in the second type of fund, because spreading – or diversifying – investments between different types of asset is a good way of managing risk. Members can choose to diversify their investments using multiple specialist assets funds but this requires more time and financial knowledge.
Over the long term, shares have historically tended to perform better than bonds or cash, which are lower risk investments. So a common strategy is for people to invest in a fund mostly holding shares until they get closer to retirement, and then start to lower the risk profile of their investments.
This shift usually takes place automatically moving the balance of investments towards less risky assets (such as bonds and cash) as the member nears retirement. ‘Target date’ funds work in a similar way.
For individuals who have a relatively large pension pot, they can take greater control of their pension and access a wider range of assets by using a SIPP (Self Invested Personal Pension). However, this is only suitable for experienced investors who are very comfortable with taking investment decisions.
Pooled investment funds
Pooled investment funds – also known as collective investment schemes – are a way of putting sums of money from many people into a large fund spread across many investments and managed by professionals. Investing this way can potentially be easier and less risky than buying shares in individual companies direct, and there are lots of funds to choose from.
There’s a huge range of funds that invest in different things, with different strategies – high income, capital growth, income and growth and so on.
Common types of pooled investment vehicles:
Why invest through a fund?
There are several reasons to invest through a fund, rather than directly buying assets, these are as follows:
What types of asset class are there?
The major asset classes which underlie the investments are:
Property is an alternative investment. Private equity and hedge funds are sometimes considered to be another asset class.
The investment manager, in the case of shared investments, or the trustees of pension funds will decide the allocation to each asset class. For each type of investment vehicle, there are rules and regulations about which assets can be held and the appropriate taxation of capital gains and income.
These three investment categories (equities, bonds and cash) can be broken down, in turn into two main types. These two types are real assets and monetary assets.
Equities, property and index linked securities are 'real' assets. This means that over the long term they should at least retain their value (in terms of purchasing power) even if inflation is high. The increase in the value of shares in a company can be due to the company itself producing higher profits (for example from higher prices, greater efficiency or a growing market) or it can be due to general factors influencing industry everywhere. Equities have historically produced a return in excess of inflation. The price of property is driven by demand, and demand increases as profits increase. Profits increase more when there is inflation, so the price of property is indirectly linked to inflation. The terms of index linked securities are such that the investment value is protected against price inflation, and they provide an income stream which is protected against price inflation as well.
Cash and bonds (except index linked) are monetary assets. There is no direct link between inflation and the expected performance of these assets. The performance is expressed in monetary terms.
This section relates to your Study Manual - Investment (Pages 67-77) - (the Study Manual can also be found in pdf format in the Resources Page of this website)
2.Think about it
Equities and Bonds
There are many different types of investment categories. See if you can think about what characteristics an equity has, and do the same for bonds.
Write your answers down to structure your revision.
3. Fact Finding
Types of Asset
Think about the organisation that you currently work for, or a company that you have previous experience of an occupational pension scheme with. Do you know what kinds of assets the pension fund was invested in?
1.Can you list two types of monetary assets?
2.Can you list two types of real assets?
You can now check your knowledge by a short test. Once completed then check your answers against those given.