As part of Professional Adviser’s commitment to helping advisers prepare for RDR, we are providing fully accredited gap-fill articles. This month, Geoff Mills, director at Rayner Spencer Mills, outlines all you need to know about the main asset classes...

Is this article for me? Read this...

What is it about?
Any financial adviser with an existing QCF Level 4 qualification may have to carry out gap fill to meet the FSA's requirements for RDR. This article will help you do that. If you have any knowledge ‘gaps' about the main asset classes, reading this article - and taking a short online test afterwards - will help you tick off those gaps.

Which learning outcomes does this article cover?
The Financial Services Skills Council (FSSC) outlined all the key knowledge criteria every financial adviser will be required to have met by 31 December 2012. This article covers gaps 76-92, plus 94, if you are following the Institute of Financial Planning's syllabus. If you are doing the Chartered Insurance Institute's, it covers gaps 30-33.

Who wrote this article?
Geoff Mills is director and co-founder of Rayner Spencer Mills, which provides fund research, fund analysis and ratings plus independent outsourced investment solutions to the UK advisory sector.

THIS article looks at the key asset classes and how their differing characteristics need to be understood so that they can be made to work together to achieve a consistent range of returns in relation to the risk taken.

The foundation of most asset allocation processes was set in the 1950s with the advent of modern portfolio theory.

The definition of the theory is that a rational investor will want to diversify their assets to maximise the return on their investments for a pre-determined and acceptable level of risk.

When putting together recommendations and constructing portfolios it is essential that the correlation between the asset classes and the funds within each asset class is considered so that any portfolio is not biased to a specific theme or style.

We will now look at the main asset classes and then finally look at how the various asset classes work together.

Once you have read and understood this article, you can take a short online test to validate your learning and to access a certificate for your CPD records. See the end of this article for more information.

Cash and cash equivalents

Cash and cash equivalents are the most liquid assets that can be held. Cash would include bank and building society savings plus cash ISA’s and National Savings accounts, whilst cash equivalents are assets that are can easily become cash such as short term government bonds, treasury bills and money market holdings.

Cash is the lowest risk investment but is not entirely without risk as interest rates may not keep pace with inflation and there is also the risk that the provider can default on the arrangement.

An assessment of a company’s financial strength and credit worthiness can help mitigate default risk but should a company go into default the Financial Services Compensation Scheme (FSCS) is available as a safety net for deposit values up to £85,000 per person per company.

Cash can be used within a portfolio to provide a lower risk element and can usually be accessed at very short notice, except for those ‘term’ accounts where there may be penalties for early withdrawal.

However, allocation to cash within a portfolio should be separate from any emergency cash fund; the latter providing cover for essential outgoings in the event of an emergency such as illness or job loss.

Overseas deposit accounts are also available but these introduce foreign currency risk and the FSCS may not be available.

Costs and charges – Interest on traditional cash savings accounts is net of basic rate tax and charges. The bank will take their charges before paying interest and this ‘margin’ will be the difference between the rate they lend money at and the rate they pay depositors. This margin on cash and cash equivalent investments is often very opaque.

Fixed interest

Fixed Interest is a broad asset class covering a range of investments offered by governments or by companies.

In simple terms, a fixed interest investment is where investors effectively lend some money to the government or the company for a set period of time and at an agreed interest rate.