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Investment: risk and reward

Investment asset classes

The main asset classes used for investment of pension funds are equities, properties, bonds and cash. Due to the higher risks involved with property and equity investment, pension fund investors expect higher returns from these assets in the long term.

Equities are company shares. They are bought and sold on the stock market. Owning shares makes the shareholder a part owner of the company. It also entitles them to a share of the profits, which are paid out as dividends. If the company does well and the shares are popular, their value will go up. If it does badly and lots of shareholders want to sell their shares, their value will go down. Sometimes this can happen very quickly.

Bonds are loans to governments (Treasury Bonds) and other borrowers, such as large companies (Corporate Bonds). Borrowers agree to pay a fixed rate of interest (the coupon) on the bond and agree to repay the loan at a later date. Bonds that pay a fixed rate of interest are sometimes referred to as 'fixed interest securities'. Index linked bonds are a particular type of bond where the interest and redemption payments are not fixed but are increased in line with inflation.

Commercial property includes offices, industrial and retail premises. Only the largest pension schemes are big enough to hold properties directly. Smaller pension funds can get access to property by investing in pooled property investment funds. Property investors receive income by way of rent from tenants and can also benefit from any increase in the value of properties. But property values can also fall and it can be difficult to value properties on an ongoing basis.

Cash is money in the bank or in very short term financial instruments. Cash investments earn short term interest. It is also easy to access the money quickly. Cash investments are not expected to fall in value although they are not absolutely without risk. Cash investments can sometimes be affected by counterparty risk, in other words, risk that the bank or other counterparty defaults.