In most developed countries, the four major asset classes are (1) common stocks, (2) bonds, (3) cash equivalents, and (4) real estate. Why are they referred to as asset classes? That is, how do we define an asset class
? There are several ways to do so. The first is in terms of the investment attributes that the members of an asset class have in common. These investment characteristics include:
• The major economic factors that influence the value of the asset class and, as a result, correlate highly with the returns of each member included in the asset class.
• Risk and return characteristics that are similar.
• A common legal or regulatory structure.
Based on this way of defining an asset class, the correlation between the returns of two different asset classes—the key statistical measure for successful diversification as will be explained in the next chapter—would be low.
Mark Kritzman offers a second way of defining an asset class based simply on a group of assets that is treated as an asset class by asset managers. He writes:
[S]ome investments take on the status of an asset class simply because the managers of these assets promote them as an asset class. They believe that investors will be more inclined to allocate funds to their products if they are viewed as an asset class rather than merely as an investment strategy.2
Kritzman then goes on to propose criteria for determining asset class status which includes the attributes that we mentioned above ...
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