- 1. There are many investment products available with varying degrees of risk and return.
- 2. Government debt can be one of the safest assets or the riskiest assets, depending on the government in question.
- 3. Alternative investments is a broad category that includes hedge funds, private capital, natural resources, real estate, and infrastructure.
This is the first part of our continuing series on The Complete Beginner’s Guide to Investing.
Types of Investments
The graph above shows the most common types of investment products and the risk and returns associated with each. Let’s walk through some of the most common asset classes.
Certificates of Deposit, Fixed Deposits
Certificates of deposits (CDs) are almost like a savings account – except that you cannot withdraw your money for a fixed, usually short, period of time. It typically offers higher interest than a savings account. If you withdraw prematurely, you would have to forfeit the interest and may also have to pay a penalty. Each consumer financial institution, such as a bank, offers different CDs that vary in nature widely.
In Singapore, “Fixed Deposits” is the more common term used to describe CDs. Most banks offer Fixed Deposits with a wide range of periods and interest rates.
Government debt can be one of the safest assets or the riskiest assets, depending on the government in question. In this section, we are describing United States government securities and Singapore government securities.
In investing circles, US government debt is presumed to be one of the safest types of investments as it is backstopped by the relative economic, industrial, and military power of the US. Additionally, the US currency is also the global reserve currency.
In the United States, common names for government securities are “Treasury Bills, Treasury Bonds, and Treasury Notes”.
In Singapore, the Monetary Authority of Singapore (MAS) issues two key classes of government securities: 1) Singapore Government Security (SGS) Bonds and T-bills and 2) Singapore Savings Bonds (SSB). The former is meant to be more rigid, where if you redeem your savings bond before the maturity of the bond, you might lose money. The latter is meant to be more flexible, and you can redeem it at any time. SSB is highly popular, is limited in availability and quantity, and is usually “over-subscribed”.
Corporate Debt (aka Bonds) And Equity (aka Shares)
Businesses can issue debt or equity to fund their capital expenses (e.g. to hire more people, to open more coffee shops). The difference is that debt holders get paid their principal plus interest back before equity holders do. However, debt holders receive a pre-determined fixed amount (the interest rate) regardless of the performance of the business. Debt is paid first after whatever cash is remaining after paying vendors and taxes.
Equity holders, in contrast, reap all of the remaining profit of the company if there is any left after debt holders have been paid. If the business exceeds expectations, the value of their equity increases (aka upside). If the business makes losses, the value of the equity decreases (aka downside). If a company goes bankrupt and all its hard assets are sold, equity holders wait at the end of the line to be paid back.
The most common instruments that a publicly traded business uses to issue debt and equity are corporate bonds and shares, respectively. For the same company, bonds are thought to be less risky than shares. However, across different companies and geographies, risks profiles of equities and bonds may be highly variable.
Investment funds are pooled investment vehicles where financial professionals manage, buy, sell, balance, and monitor the asset classes described in this article. There are primarily two types of investment funds, broadly speaking.
A passive investment fund publishes upfront to investors a certain benchmark or index it will follow. For example, it could be called “fund that invests in all of the top 500 largest companies in the United States, weighted by their market capitalization value”. Essentially, the managers of this fund buy and sell shares in the 500 companies every day so that the weightage of each share is appropriately adjusted to account for fluctuations. They don’t attempt to make any determination on what the value of each company is. They follow the market.
An active fund publishes the investment strategy and tactics that they deploy, and together with past performance, claims that they can make returns higher than the market by taking additional risk relative to the baseline risk of the market. For example, some active funds try to determine what the true value of the company is versus what its current price is and acts on assets that they believe are mispriced.
There are many investment funds. Each of them focuses on a combination of different features such as asset class, sector, geography, risk tolerance, strategy, and tactics. There are also “purpose funds” such as those for retirement, growth, dividend, and protecting the environment (called ESG funds).
Alternative investments do not fall under traditional investments, such as structured deposits, bonds, and equities. This is a very broad category that includes hedge funds, private capital, natural resources, real estate, and infrastructure.
Commodities and Natural Resources
Commodities generally refer to the most basic forms of goods that are grown on or extracted from the Earth. Examples include oil, gas, soybeans, silver, gold, and uranium. Precious metals such as gold and silver are thought to move in relatively opposite directions of shares (the industry term for this is “negatively correlated”), and investors purchase such commodities to “hedge” against volatility in the prices of shares.
You can purchase a single plot of land or an apartment, and that would be considered an investment too. In the public markets, a popular asset class is a “Real Estate Investment Trust” or REIT. A REIT is a holding company that owns multiple land plots and properties. The risk for this class of assets varies largely between geographies and property types.
Private Equity or Private Capital
Once upon a time, the world’s largest canned soda company was not 80,000 employees strong, nor was it traded on a public exchange. It had perhaps 500 people, but its revenue was growing at 1,000% per annum, and nobody knew about it. You cannot buy or sell its shares as much as you cannot buy or sell the shares of your privately owned neighbourhood convenience store.
A business called a “private equity fund” is specialised to hunt down the owners of these kinds of privately held businesses and pitch to the business owners to receive an investment from the fund. In exchange for the investment, the private equity fund will receive a substantial number of shares, or equity. With enough equity, the private equity fund is able to make business decisions which will grow the value of the company and thus make good on their investment. After some years, the private equity fund and the business owners may choose to sell the company through a merger and acquisition deal or arrange for an initial public offering.
If you invested in a private equity fund, you would be called a Limited Partner. As a Limited Partner, you would have to pay the managers of the fund a fee (e.g. 2% of your invested amount per annum). With this, you may share profits with the managers of the fund (e.g. 20%) when the decision is made to sell the business or bring it public years later.
Access to private equity used to require a minimum investment of S$1-2 million in the past, but this amount has come down to S$100,000 in recent years.
Hedge funds are pooled investment vehicles that commonly take the riskiest and most arcane strategies to achieve high returns. These strategies or tactics could range from using daily satellite images to estimate the vacancy of cargo ships passing through the Suez canal to using supercomputers to trade milliseconds faster than the rest of the market. They then use the signals, intelligence, or speed gained to trade on assets and instruments to potentially make larger profits than the market. You may need to be a high-net-worth and accredited investor to participate in hedge funds.
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