Asset Classes & Asset Types

High-multiple "growth" stocks (tech, biotech, consumer discretionary) have earnings and cash flows concentrated far in the future — they are long-duration assets. Like long-dated bonds, they are highly sensitive to changes in the discount rate. When 10-year real yields rise from 0% to 2% (as happened 2021–22), the appropriate valuation discount rate increases, compressing multiples — a purely mechanical effect independent of any change in business fundamentals. The Nasdaq fell ~33% in 2022 while earnings expectations were broadly flat: this was a duration compression event, not an earnings recession.

Normal (upward sloping): Long rates > short rates. Typical in growth expansions. Reflects term premium (compensation for holding longer-duration instruments) and expectations of higher future short rates. Flat: Long and short rates approximately equal. Often a transition signal — precedes inversion or normalisation. Inverted: Short rates > long rates. Historically the most reliable recession predictor in the US (preceding every recession since 1955 with only one false signal). Mechanism: central bank tightens short rates above expected future short rates; market prices in eventual cutting cycle via lower long rates. The 2-year/10-year curve inverted in July 2022 — a widely watched signal.

Private real estate and infrastructure funds typically value their assets quarterly using appraisals (professional valuations) rather than market-observed prices. Appraisers use comparable transactions and discount rate models, but these are inherently backward-looking and change slowly. The result is return smoothing: reported quarterly returns are artificially stable, and the implied volatility of private assets is far lower than their economic risk. This makes diversification benefit calculations using private assets misleading — the apparent low correlation with public equities partly reflects the lag in valuation, not genuine independence. The Geltner (1993) "unsmoothing" methodology attempts to recover the true underlying volatility. Investors should apply a 2–4× multiplier to reported private asset volatility for stress-testing purposes.

Contango: Futures prices are above spot prices (forward curve slopes upward). As a futures contract approaches expiry, its price converges toward the (lower) spot — the investor who "rolls" the position sells the expiring contract at near-spot and buys the next maturity at a higher price. This roll is a cost (negative roll yield). Typical in energy markets during gluts (e.g., crude oil 2014–2016, 2020). Backwardation: Futures prices below spot prices. Rolling generates positive roll yield (sell expiring at near-spot, buy next maturity below spot). Typical during supply shortages or heightened near-term demand. The long-run average roll yield in commodity baskets is near zero — periods of contango and backwardation roughly balance out historically.

For a UK investor holding a US equity fund, the USD/GBP exchange rate creates uncompensated risk (no equity risk premium for FX). Whether to hedge depends on: (1) Correlation: During risk-off periods, GBP tends to weaken (USD strengthens as safe haven) — unhedged USD equity provides natural portfolio protection. (2) Hedge cost: The cost of a forward hedge ≈ interest rate differential (currently ~1–2% for GBP vs USD). Over 1–2 year horizons this is material. (3) Horizon: Over 10+ years, PPP suggests currencies mean-revert — the risk of unhedged FX diminishes relative to equity risk. Common institutional practice: hedge 50–75% of developed market non-USD equity exposure; leave emerging market FX unhedged (hedging costs are prohibitive) or use currency overlay strategies.

Delta (Δ): Rate of change of option price with respect to spot price. A delta of 0.5 means the option price moves £0.50 for every £1 move in the underlying. At-the-money options have delta ≈ 0.5; deep in-the-money ≈ 1.0. Gamma (Γ): Rate of change of delta — how much delta changes as spot moves. High gamma near expiry means a small move in spot dramatically changes the option's delta. Vega (ν): Sensitivity to implied volatility. Long options are long vega — you benefit from rising volatility. Theta (Θ): Time decay — options lose value as expiry approaches, all else equal. Long options lose theta daily; short options gain theta. Delta-hedged portfolios that are long options must "pay for" vega through theta.

Private equity (PE) funds draw committed capital over the first 3–5 years (the investment period) and return capital plus profits over the following 5–10 years. In the early years, fees and write-downs on newly acquired, unimproved companies cause the fund's IRR to appear negative or low — the "J-curve." Only as investments are improved and exited do returns improve. This creates a J-shaped IRR trajectory over time. Investors who evaluate PE performance at year 3–4 will systematically underestimate ultimate returns; those who evaluate only the best-performing vintage years will overestimate. The commitment schedule must be planned 10–12 years in advance for cash flow management.

The negative bond-equity correlation that underpinned the 60/40 portfolio's risk-adjusted performance from 1998 to 2020 is not a structural constant — it is a regime-dependent relationship. Deflationary/demand-shock recessions (2001, 2008, 2020): Growth fear drives equities down and rates lower (bonds up) — strong negative correlation; bonds are excellent equity hedges. Inflationary recessions (stagflation) (1970s, 2022): Inflation drives rates higher (bonds down) AND growth fears drive equities down simultaneously — positive correlation; bonds provide no equity hedge. In 2022, a 60/40 UK portfolio fell ~15%, as both equities (−16%) and bonds (−17%) declined together. Investors relying on the "bonds always hedge equities" assumption were exposed to regime risk.