What is an Asset Class, or Sub-Asset Class?
To explore this question we must first break down what is an asset and then what are classes of such assets.
Sullivan(Note 1.) provides a good definition of assets as being ” assets are economic resources. Anything tangible or intangible that is capable of being owned or controlled to produce value and that is held to have positive economic value is considered an asset. Simply stated, assets represent value of ownership that can be converted into cash (although cash itself is also considered an asset).”
While the, somewhat simplified, definition of asset class within the online dictionary of investment terms, Investopedia , defines an asset class as follows:
A group of securities that exhibit similar characteristics, behave similarly in the marketplace, and are subject to the same laws and regulations. The three main asset classes are equities (stocks), fixed-income (bonds) and cash equivalents (money market instruments).
It should be noted that in addition to the three main asset classes, some investment professionals would add real estate and commodities, and possibly other types of investments, to the asset class mix. Whatever the asset class lineup, each one is expected to reflect different risk and return investment characteristics, and will perform differently in any given market environment.
Similarly The Free Dictionary defines it as “Different types of investments that behave similarly and are subject to most of the same market forces“.
As such the common definition as to what makes an asset class is whether a group of assets have the same or similar characteristics, behavioural patterns, laws and regulations.
‘Sub-‘ is the prefix, originating from Latin, “freely attached to elements of any origin and used with the meaning ‘under’, ‘below’, ‘beneath‘” , “secondary” or “subordinate”.
As such a definition of sub-asset class may be “a group of securities, all exhibiting similar characteristics, behaving similarly in the marketplace and subject to the same laws and regulations, but which also fall into a larger group of securities with that larger group having many, but not all, characteristics and behavioural patterns in the marketplace”.
Variance Between Asset Classes
The most difficult aspect of categorising investments into one asset class or another (made even more difficult at the sub-asset class level) is the degree of variance required in an investment for it to move between categories.
For example any exchange listed investment vehicle, regardless of its underlying assets, may technically be a corporate entity that has issued securities in itself (most likely in the form of equity) and therefore be subject to the characteristics and behaviours of a listed equity class of assets while simultaneously being subject to the characteristics and behaviours of its underlying assets (for example commercial real estate).
Testing Venture Capital
To determine if venture capital is an asset class it must pass the two tests of being an asset and being of a distinct class.
a. Asset Test: a venture capital investment is an economic resource that is capable of being owned and controlled to produce value and that is held to have a positive economic value and therefore meets the asset test; and
b. Class Test: venture capital investments, while potentially covering a broad spectrum of investees across almost unlimited industries and from the very earliest stage of a venture through a latter stage of a venture (therefore this diversity of the investment having a significant impact on the investments characteristics and behaviours) remain a group of securities that exhibit similar characteristics (many of the risks and behaviours of this diverse range of investments remain universal to the group), behave similarly in the marketplace and are subject to same laws and regulations within each national geographic location and therefore meet the class test.
Having passed both the asset and class test venture capital must be seen as an asset class, but is it a sub-asset class rather than an actual asset class?
If it is assumed that by venture capital we mean a managed pool of investment funds to be invested into unlisted ventures, generally of an early stage nature at the time of investment, then this type of investment has the following characteristics and behaviours (not an exhaustive list):
• Investment in exchange for equity;
• Unlisted investee entities;
• Industry or sector is unlimited, except to such extent as the investment is into the business enterprise and not directly or indirectly with regard to an underlying asset (i.e. real estate, commodities, collectibles, further re-investment of funds);
• Investments are commonly expected to be of a 5 – 10 year timeframe;
• Risks associated with the investment are considered to be high; and
• Exit from the investment is most commonly by way of exchange listing or trade sale of the investee.
Given the equity basis of the investment and other common equities characteristics, such as means of exit from the investment, venture capital falls into the equity asset class.
It is, at the time of investment at least, an investment into an unlisted entity, however, its variance in characteristics and behaviour are such it is sufficiently dissimilar to ‘private equity’ investment as to warrant its own sub-asset classification. This is particularly evident in the behavioural difference of the investments given the stage of development of the respective classifications (i.e. ‘early stage’ verses ‘latter stage’), such behavioural difference would in turn be reflected in the risks associated with each investment.
In conclusion there are both asset classes and sub-asset classes (reference to the Table of Asset Classes indicates there are also sub-sub-asset classes).
The variance between each sub-asset class has not been determined and detail of other research determining the variance has not been sourced at this time.
Venture capital investment is a member of the equities asset class, and a component of the unlisted equities classification, but is sufficiently different from other unlisted equities (i.e. ‘private equity’) as to require its own sub-asset classification.
1. Sullivan, Arthur; Steven M. Sheffrin (2003). Economics: Principles in action. Upper Saddle River, New Jersey 07458: Pearson Prentice Hall. pp. 272. ISBN 0-13-063085-3.