Of portfolio building and asset classes

Before diversifying, investors should also consider the legal and regulatory framework in which they operate. There could be regulatory reasons limiting the choice of asset classes. For instance, banks and life insurance companies are frequently subject to regulatory restrictions limiting investment. 

Real estate laws vary from state to state and there are limitations on land transfers and usage. Tax implications should also be taken into account. A particular asset class may give high returns, but could also be subject to higher tax.

Traditional asset class divisions used by investors to diversify include:

§            Domestic common equity

§            Domestic fixed income: Investors may choose on the basis of the security (intermediate-term and long-term). Recently inflation protection has also been used to distinguish between nominal bonds and inflation-protected bonds.

§            Non-domestic (international) common equity: Here, distinctions are made between developed market equity and emerging market equity.

§            Non-domestic fixed income. 

§            Cash and cash equivalents

Besides these, there are 'alternative assets', a term used to refer to all asset classes excluding the above. These include art, real estate, private equity, natural resources, commodities, currencies, derivatives and structured products.

Care should be taken that 'alternate assets' are further broken out as separate asset classes as they are far from being homogenous.

As India develops economically and people become more financially savvy, newer asset classes will be formed continuously to address the increasing need for diversification and portfolio allocation.

It is also important that the investor frequently evaluates his portfolio to find out whether the allocation strategy is still appropriate. 

To sum up, a deeper understanding of the various asset classes and their interlinkages will help investors to comprehend the long-term implications of risk and return on the portfolio.