What Is a Sub-Asset Class?
A sub-asset class is a sub-segment of a broad asset class that is broken down to provide more identification or more granular detail of the assets within the subclass. Sub-asset classes are grouped by common characteristics, also displaying characteristics of the broad asset class.
Stocks, for instance, are an asset class, and investment trusts are an example of a sub-asset class within the broader universe of stocks. These trade similarly to stocks, but have some unique characteristics. Commodities also compose a broad asset class, while metals and agricultural commodities each make up separate sub-asset classes.
- A sub-asset class is a group of assets that share similar characteristics with each other, and also with the broader asset class it is part of.
- Looking down to the sub-asset level is important if looking to build a diversified portfolio.
- Stocks, fixed income, and commodities are common asset classes that all have sub-asset classes within them.
Understanding the Sub-Asset Class
Sub-asset classes are generally defined by certain characteristics that make them unique within the bigger universe of the asset class. They are most commonly used to break down broad market asset classes like equity, fixed income, and commodities.
Sub-asset classes can be an important aspect for style investing and standard investment management strategies, which rely on diversification and modern portfolio theory. Diversifying asset classes in a portfolio balances its exposure to risks and reduces the volatility of the overall portfolio. Sub-asset classes help to further identify areas where the portfolio can be diversified.
Buying a random bunch of stocks, for example, won't necessarily create a diversified portfolio. Buying stocks across different asset classes, sub-asset classes, industries, and sectors will create a more diversified portfolio.
Within the equity universe, numerous investments have unique characteristics that provide for sub-asset class categorization. Real estate investment trusts (REITs) and master limited partnerships (MLPs) are two examples. These investments trade alongside other stocks on the stock market, however, they have unique characteristics associated with their incorporation that define them as an equity sub-asset class.
Other equity features may also be used to define sub-asset classes. Capitalization allows for sub-asset classes such as large-cap, mid-cap, or small-cap. Equities may also be further delineated by characteristics such as growth, value, or blend.
Within the fixed income universe, a number of sub-asset classes exist for investors. Cash, loans, and bonds are a few examples. Each has fixed-income attributes with its own unique investment characteristics.
Fixed income sub-asset classes may also be grouped by duration (maturity) and quality. Durations can be short, intermediate, or long. Credit quality sub-asset classes for fixed income investments may also be defined by their credit rating, which is provided by a rating agency. Junk bonds (also called high-yield bonds) have low credit ratings and are riskier investments and make up a distinct asset class.
Bonds also are categorized by the issuer, whether these are sovereign or municipal governments, agencies, or corporations; as well as whether the issuer is domestic or foreign.
Preferred shares are technically a sub-asset class of equity, but in many ways, they are hybrid assets that lie between stock and bonds. They offer more predictable income than common stock and are rated by the major credit rating agencies.
Commodities offer a range of sub-asset classes that can include metals, oil and gas, as well as grains and other types of agricultural products. While these are all called commodities, these sub-asset classes are very different. Metals are mined, while agricultural commodities are grown or raised.
A soft commodity refers to commodities that are grown rather than extracted or mined. Soft commodities represent some of the oldest types of futures known to have been actively traded. This group of agricultural products may include products such as soybeans, cocoa, coffee, cotton, sugar, rice, and wheat, as well as all manner of livestock.
This is in contrast to hard commodities such as mined metals (copper, gold, silver, etc.) and energy extraction (crude oil, natural gas, and products refined from them), which are waiting in the earth for extraction, as opposed to being planted and nurtured to maturity. Hard commodities can also be found in similar geological deposits around the world, whereas soft commodities depend on regional climate conditions to grow.
Example Using Sub-Asset Classes in Investing
Sub-asset classes can be important for targeted investing or when seeking to build a diversified portfolio. By determining specific characteristics of sub-asset classes, investors can make focused investments across risk levels.
For example, a 60/40 asset allocation fund may define its strategy as investing 60% of assets in equity and 40% in debt. While this is a balanced portfolio, the investment managers still have a wide range of sub-asset class options they can choose from for each portion.
They may further decide to put 50% of their stock purchases into growth investments, and the other 50% into value investments. They may also stipulate that all stock investments must be in at least mid-cap in size or bigger.
For the bonds component, they may decide to put 20% in cash or cash equivalents like certificates of deposit (CDs). They may put 35% in short-term commercial paper, 25% in government and municipal bonds, and the remaining 10% in high-grade corporate bonds.
These percentages could be broken down even further. For example, the 25% (of the 40% of the portfolio allocated to government and municipal debt) could be 10% long-term treasuries, 10% short-term treasuries, and 2.5% of both short-term and long-term municipal bonds.
Investors can determine their own ideal asset allocation strategy, or seek out the guidance of a financial advisor for help.