Investment Insights - Asset Allocation and Overlooked Claims

Investment Insights - Asset Classification and Overlooked Debt

I’ve been involved with stocks for about three years. In the first year, I was a novice retail investor, losing my way with Chinese concept stocks, buying purely on intuition without understanding the business. The second year was slightly better; I benefited from the Reddit and Tesla boom in the U.S. stock market, achieving an annualized return of over 40%. The third year was favorable as well, with gains from Cloudflare and Google, reaching an annualized return of over 50%. The biggest improvement over these two years has been my ability to understand company business structures and gain a deeper understanding of business models and corporate cultures. However, I still lack professional knowledge, so I plan to write some articles to document my learning experiences.

Asset Classification

According to common asset classification methods, assets can be divided into the following categories:

Asset Category	Professional Definition (Financial Language)	Common Subcategories / Forms	Main Uses
Cash and Cash Equivalents	Short-term, low volatility, easily liquidated	Cash, demand deposits, time deposits, money market funds, short-term government bonds	Liquidity, survival funds
Fixed Income Assets	You are a creditor, receiving fixed or agreed returns	Government bonds, municipal bonds, corporate bonds, convertible bonds, ABS, private credit	Stable returns, reduce volatility
Equity Assets	You are an owner, receiving residual returns	Stocks, private equity, VC, equity funds	Long-term growth, beat inflation
Real Assets	Physical or scarce, inflation-resistant	Real estate, land, commodities, gold, energy	Inflation hedge, risk aversion
Alternative Assets	Non-traditional, complex structure	Private equity, hedge funds, art, crypto assets	Diversify risk, enhance returns

From the perspective of ordinary Chinese retail investors, the most familiar assets are cash, demand/time deposits, stocks, gold, and real estate. Some younger friends might also dabble in cryptocurrencies. These are assets that are more commonly encountered and have relatively high exposure, so people are quite familiar with them.

Overlooked Debt

Referring to the asset table above, you’ll notice that debt assets have the lowest exposure. When I started investing, I rarely paid attention to fixed income assets. On one hand, there were too many negative news stories about municipal bonds and the Evergrande crisis. On the other hand, brokers tend to focus on stocks. However, I later discovered that this is a great asset class. It forms a spectrum based on risk/return and can be flexibly linked with stocks (such as convertible bonds), fully meeting various investment needs.

Debt Classification

Based on the issuer, debt can be divided into the following types:

Issuer	Professional Name	Practical Understanding	Common Examples
Sovereign	Sovereign Bonds	The borrower is a country	Government bonds, U.S. Treasuries, Japanese bonds
Local Government	Municipal Bonds	Local finance	Municipal bonds
Government Agencies	Agency Bonds	Semi-official institutions	Fannie Mae, Freddie Mac
Corporates	Corporate Bonds	Companies borrowing money	Corporate bonds
Financial Institutions	Financial Bonds	Banks/Insurance	Bank subordinated bonds

Government bonds are typically considered risk-free returns. For example, a 10-year U.S. Treasury bond can offer over 4% risk-free annualized returns. Local government bonds are issued by local governments and directly tied to fiscal policies. Agency bonds are issued by market-oriented institutions backed by government guarantees or endorsements, but the government is also responsible for them. This is different from some Chinese municipal bonds, which are shell companies used to isolate risk, and the government is not responsible for them, posing significant risks. More similar are China’s three major policy banks.

Debt Risk Structure

Based on the risk spectrum, debt can be divided into the following categories:

Risk Level	Risk Name	Core Credit Source	Typical Assets/Examples	Common Terms	Main Risk Points
R0	Risk-free / Near Risk-free	Sovereign local currency credit	Local currency government bonds, T-Bills	”Absolutely safe” “Risk-free rate”	Inflation, interest rates
R1	Sovereign Credit Risk	National credit (non-local currency/weak fiscal)	Foreign currency government bonds, emerging market government bonds	”Countries can default too”	Sovereign default, exchange rates
R2	Quasi-sovereign / Policy Credit	Central government system	Policy bank bonds, agency bonds	”Quasi-government bonds”	Policy changes
R3	Investment Grade Credit Bonds	High credit enterprises/financial institutions	AAA–BBB corporate bonds, high-quality financial bonds	”Fixed income” “Stable returns”	Spread widening
R4	Speculative Grade Credit Bonds	Weak credit entities	BB and below high-yield bonds	”High-yield bonds” “Junk bonds”	Default risk
R5	Distressed / Non-performing Debt	Problematic entities	Defaulted bonds, restructured bonds	”Non-performing assets”	Principal loss
R6	Structured / Tail Risk Debt	Structure design rather than credit	Subordinated debt, ABS subordinate, CLO Equity	”Structured products”	Non-linear collapse

Government-related debt forms a spectrum from local currency government bonds to foreign currency government bonds to quasi-government bonds, with risk mainly depending on national credit. For example, U.S. government bonds are far less risky than Venezuelan government bonds.

Corporate and financial institution debt ratings like AAA and BBB are given by third-party agencies such as S&P and Moody’s. Similar domestic agencies include China Chengxin. These ratings are included in some regulatory requirements. For example, a fund labeled as stable cannot hold debt below a certain rating. Lower-rated debt and defaulted debt are considered a game for the brave.

Other structured products like ABS involve layering and combining credit risks for arbitrage. The most typical example was Ant Financial’s previous operations:

Using Huabei/Jiebei to “bundle small loans into bonds” and sell them to the market (ABS), then using the proceeds to continue lending, essentially: Loan → Bundle → Sell → Re-loan → Scale up (leverage)

Ultimately, the risks fall on banks and society, while Ant profits from the process, effectively using technology to force the growth of loan scales.

Relationship Between Debt and Equity

From the flow of company funds, operating funds move from creditors to shareholders, with stocks at the end and debt in the middle layer. Stocks can be seen as arbitraging the ultimate risk of company operations, while debt arbitrages the middle-layer risk.

Dimension	Debt	Equity
Level	Middle-layer risk arbitrage	Ultimate layer cognition/narrative arbitrage
Claim Nature	Contractual certainty claim	Residual uncertainty claim

There is also an asset type between debt and equity called convertible bonds, where the investor’s debt comes with an additional feature allowing conversion into equity under certain conditions.

From the company’s perspective:

I give you a bond with a low interest rate

But if I do well in the future, you can buy my stock at today’s price.

From the investor’s perspective:

It’s okay if the interest is low now; there’s a guaranteed return

If the company performs well and the stock takes off, there’s a chance for higher returns.