Asset classes are nothing to be frightened of. Quite simply, they are the types of investment that a charity can make.
The main asset classes are company shares (equities), bonds, cash deposits and alternative investments such as property funds or private equity. Typically, a charity will hold a mix of these different assets to avoid the risks of placing all of its eggs in one basket.
The mix that a charity chooses will depend on the level of risk it is comfortable with, its returns and income requirement and its investment timescale. Getting the right mix of assets is much more important to long-term performance than choosing the right stocks.
So if you are just starting out, what do you need to know about each asset class? Here is a basic guide.
Equities, or shares, are investments in companies quoted on the stock market. The investor will share in the success (or otherwise) of the company. If the company does well, the value of the shares will rise. The investor can also receive a share of the company's profits as annual dividends.
The UK stock market has long been the most popular for charity investors with their own portfolios. Nearly 90 per cent hold UK equities, according to research carried out at the end of 2007 by JP Morgan Asset Management. About half hold overseas equities.
Investing in equities has produced good returns over the long term, but investors must be prepared for volatility, as illustrated by the ups and (mainly) downs caused by the current global economic downturn.
Between 1900 and 2007, UK equities offered an average annual return of 9.5 per cent, compared with 5.2 per cent for government bonds and 5 per cent from cash on deposit, according to investment management firm Sarasin Chiswell. It has also found that more charities are seeking access to markets through pooled investments, such as unit trusts and common investment funds, rather than by investing directly in the stock market.
Bonds are IOUs that are issued by governments or companies. For governments, they are an alternative to taxes as a way of raising money; for companies, they are an alternative to issuing shares. Bonds may be freely traded, although their value changes from day to day, so you may not get back the price you paid for them.
Every bond has a nominal or 'par' value, which is the value returned to the investor when the bond 'matures' - in other words, when the loan ends. The 'coupon' is the interest rate that the government or company agrees to pay the investor. A coupon of 5 per cent would mean the investor receives £5 a year on a £100 bond. Most bonds pay a fixed rate of interest, but some pay a variable or 'floating' rate.
Gilts are bonds issued by the UK government and are regarded as virtually free of credit risk. Over the years, they have provided a higher yield than cash on deposit and a real return over inflation.
Bonds issued by companies are known as corporate bonds. Unlike bonds issued by a government, the investor takes the risk with a corporate bond that the company will stay in business. Because of the higher risk, they offer higher returns than government bonds.
About two-thirds of charities have some money in bonds, although bonds make up only 3 per cent of total charity investment, according to JP Morgan.
Cash investments are short-term and offer the investor easy access to their money while also earning interest. They include money held in deposit accounts or short-term money market investments. Treasury bills, certificates of deposit and other short-term investments are called cash or cash equivalents.
The advantage of holding cash is that, whatever happens in the financial markets, you have a safe and interest-earning investment that can be accessed at short notice. Cash investments are low-risk and predictable, but returns are often lower than bonds or shares and may not keep pace with inflation over time.
Investors often move more money into cash deposits when the outlook for stock markets is gloomy, because it is a way to bide one's time until the markets stabilise. The downside, however, is that when stock markets are struggling, interest rates tend to be low, which reduces the return from cash investments.
Cash represents 4 per cent of charity investment, according to JP Morgan. These are short-term investments, such as holding cash on deposit.
'Alternative' asset classes include commercial property, hedge funds and private equity. These have been an increasing feature of charity portfolios in recent years, but the falling property market and the credit crunch could make them less attractive in the future.
Commercial property is the most popular alternative asset for charities, either through direct investment in property or a property fund. The disadvantage of property investment is that it is harder to get out of than some other asset classes and is often regarded as a long-term commitment. Historically, it has produced a return somewhere between equities and government bonds.
The reputation of hedge funds has been damaged by the speculation affecting bank shares on the UK and US stock markets, in which funds betting on the downward movement of financial stocks made massive profits. Hedge funds are generally run in a secretive way and based offshore. They seek to make money whatever is happening in the market.
Private equity funds take over companies and make them more profitable and valuable by making them more efficient - and often by putting in new management. Some have been criticised by trade unions for shedding workers as part of their efficiency drives.
These funds made very high returns before the economic downturn, when debt was cheap, but are likely to make lower returns in the future.
A quick guide to investment terms
Absolute return - Rather than comparing performance with an external benchmark, an absolute-return approach aims to generate returns whatever the market
Bear market - When the stock market is falling and investor confidence is low
Bull market - When the stock market is rising and investor confidence is high
Common investment fund - A pooled investment in which only charities may invest or deposit
Derivatives - A way of investing in a product or security without having to own it
Earnings per share - Pre-tax profits divided by the number of shares. This gives an indication of the wealth created by the company per share
Liquidity - The ease of turning an investment into cash
Pooled investment vehicles - An investment that allows people to pool their money rather than investing directly
Price-earnings ratio - The price an investor is paying for £1 of a company's earnings. It shows the relative expense of a stock
Secondary market - A market in which an investor buys an asset from another investor, rather than from an issuer
Security - A contract that can be given a value and traded, such as a stock, bond or mortgage debt
Yield - The annual rate of return on an investment, expressed as a percentage.