Glossary
Glossary of Investment Terms
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Absolute Return An investment strategy aiming to achieve a given level of long-term return, rather than a return relative to a specific index, benchmark or inflationary measure.
Accumulation Units Units in a collective investment scheme where income is automatically reinvested to increase the unit value.
Active Management An investment management approach based on making informed investment judgments, as opposed to a 'passive' approach, which mirrors the overall make-up, and therefore performance, of the market (or benchmark). The former aims to outperform the benchmark through skill: by holding the better performing stocks, but can of course also underperform if the securities held underperform the market.
Active Risk A measure of estimated volatility of fund performance against a benchmark. It is defined as the forecast standard deviation of annual returns versus the benchmark. Active risk is usually quoted ex-ante. The ex-post measure of volatility of actual returns is referred to as realised tracking error. Also known as forecast tracking error or relative risk.
Alpha The return on an actively managed portfolio over and above a stated market benchmark. This amount is attributed to 'manager skill'.
Alternative Investments The term alternative Investments refers to investments in alternative asset classes. This includes property, hedge funds, commodities, private equity, and infrastructure. Investment assets outside the 'traditional' investment classes of cash, bonds, and shares.
Annualised Return The rate of return for a given period expressed as the equivalent average return per year.
Asset Allocation The allocation of a portfolio's assets between asset classes/markets.
Asset Class Types of investments that a fund invests in for instance, equities, fixed income, multi-asset.
Authorised Fund A pooled fund which is subject to set FSA regulations. This is so it can be marketed to the general public.
Benchmark An index or a market average that a fund's performance is measured against.
Beta A measure of the sensitivity of an asset's return to the market. Beta defines the relationship of the returns from a given stock, mutual fund, or portfolio relative to the overall stockmarket returns.
The returns on a security with a beta of one will move in line with the market; if the beta is greater than one the security will exaggerate market returns; if it is less than one it will under reflect market moves; and if the beta is negative, security and market returns move in opposite directions.
Bonds A bond is the generic name for a tradable loan security issued by governments and companies as a means of raising capital. The holder of the bond receives repayment of the capital at a future specified date (the maturity date) and a fixed rate of interest for the life of the bond.
Book Cost The original cost of an investment compared to the current market value.
Collective Investment Scheme
(CIS) A collective investment scheme is a way of investing money with others to
participate in a wider range of investments than feasible for most individual
investors, and to share the costs and benefits of doing so. Generally,
collective investment schemes have the following two characteristics:
– the participants do not take part in the day to day control of the
underlying property.
– the contributions of the participants and the profits or income out of
which payments are to be made to them are pooled.
Commodities A bulk of goods such as agriculture, energy, grains, metal, and foods traded on a commodities exchange or on the spot market. There is a broad universe of over 100 different commodities that can be used to generate attractive investment returns.
Convertibles A bond that can be converted into a predetermined amount of the
company's equity at certain times during its life, usually at the discretion
of the bondholder.
Corporate Bond Corporate bonds are those issued by companies. However, the term is also used to cover all bonds other than those issued by governments in their own currencies. Therefore the 'credit' sector, as it is often known, includes issues by companies, supranational organisations and government agencies. The key feature that distinguishes corporate bonds from government bonds is the risk of default – see credit risk.
Correlation Correlation is a measure of the relationship between two variables, i.e. two share price return series. If two share price returns are highly correlated, when one performs above its average return it is likely that the other will also perform above its own average return. For example, all petroleumrelated stocks tend to have a high degree of correlation because of the same forces that influence their share prices. Conversely gold stock prices are not closely correlated with utility stock prices because the two are influenced by a different set of variables. To measure this relationship we use the correlation coefficient. The values of the correlation coefficient range from -1 (perfect negative correlation), through 0 (no correlation) to +1 (perfect positive correlation). It is important to note that correlation discloses nothing about the average returns themselves i.e. the trend. Correlation is a time dependent variable i.e. it varies with time.
Coupon The regular interest payment paid on a bond. Given as a percentage of the nominal value of the stock.
Credit Rating A bond issue is given a credit rating according to how much investment risk is associated with the bonds – i.e. how likely it is the issuer will be able to meet interest (coupon) and capital (principal) repayment obligations.
The higher credit ratings (such as AAA) mean that the issuer is likely to be able to meet these obligations and thus can offer bonds with lower interest rates and still attract investors. Bonds with higher ratings are referred to as investment grade, those with lower ratings as noninvestment grade (i.e. D to BB+). See also default risk.
Credit Risk The risk a bond issuer will default on their obligations, or the risk of default of counterparties to OTC contracts such as swaps. Credit ratings are provided by agencies such as Standard & Poor's.
Currency Hedging Currency risk can be mitigated by hedging using derivatives.
Currency Risk Volatility of foreign exchange rates creates currency risk when investing in any securities which are not in an investor's base currency.
For example, if an investment in an overseas market provides a positive return of 5% but overseas currency exchange rate deteriorates relative to the base currency (currency in which the fund is valued), the return on the overseas invest will be less, unless the currency exposure is hedged back to the base currency.
Current Yield See yield.
Default Risk The risk that an issuer of bonds, government or corporate, will not meet payments either of regular coupon payments or final principal. Credit rating agencies grade company and government issues to show the likelihood of this. An investor can diversify to decrease the risk, by holding a variety of bonds from different issuers to decrease the impact of the default of any one issuer.
Delivery Versus Payment (DVP) A trade settlement where securities and cash move simultaneously and in opposite directions between settlement parties.
Derivatives A financial instrument whose characteristics and value depend upon the characteristics and value of an underlier, typically a commodity, bond, equity or currency. Examples of derivatives include futures and options. Investors sometimes purchase or sell derivatives to manage the risk associated with the underlying security, to protect against fluctuations in value, or to profit from periods of inactivity or decline.
Distribution Yield The Distribution Yield reflects the amounts that may be expected to be distributed over the next twelve months as a percentage of the midmarket unit price of the fund as at the date shown. It is based on a snapshot of the portfolio on that day. It does not include any preliminary charges and investors may be subject to tax on distributions.
Diversification Investment into a number of different types of assets, markets and geographical areas in order to reduce risk.
Dividend The company distribute a certain amount of their after tax earnings to shareholders as cash or shares. The company decide how much dividend will be paid (if any) and when. A dividend is not guaranteed for ordinary shareholders.
Dividend Yield The return the annual dividend of a share represents in relation to the current share price.
dividend yield = annual dividend per share/current market price.
Draw Down When investing in certain types of funds, notably venture capital funds, an investor commits to invest a sum of money but does not give it all to the fund manager at the outset. As the fund manager makes investments, money is drawn down, i.e. requested from the investors.
Duration The duration of a bond is the sum of the present value of the future income and redemption payments, weighted by the number of years until receipt. Modified duration is a measure of the sensitivity of the price of a bond to changes in its redemption yield.
Earnings Growth The percentage change in a company's earnings per share over a period, compared with the same period from the previous year.
Earnings Per Share A calculation used to show company profits – dividing profits after tax by the number of shares in issue. Earnings per share is the basis for the calculation of the PE ratio (price/earnings ratio).
Earnings Yield See yield.
Effective Duration Of Fund In Years Effective duration provides a measure of a fund's interest-rate sensitivity—the longer a fund's duration, the more sensitive the fund is to shifts in interest rates. The relationship between funds with different durations is straightforward: A fund with a duration of 10 years is twice as volatile as a fund with a five-year duration. Duration also gives an indication of how a fund's NAV will change as interest rates change. A fund with a five-year duration would be expected to lose 5% from its NAV if interest rates rose by one percentage point or gain 5% if interest rates fell by one percentage point.
Equity A share in the ownership of a company (as distinguished from a loan to a company, such as a bond).
Ex Ante See Tracking Error.
Ex Dividend To clarify who receives the dividend on a share that is sold around the time the dividend is due, a date is fixed when a share goes ex-dividend. Anyone buying after this date will not receive the dividend. A share price will normally fall by the amount of the dividend on the day that it goes ex-dividend.
Flat Yield See yield.
Fund of Hedge Funds A fund of hedge funds is a fund that invests in a basket of underlying hedge funds. Funds of hedge funds are typically diversified across a number of different strategies and underlying managers. Benefits of this approach include diversification across strategies and underlying funds as well as access to high quality managers that would otherwise be closed to new investment or that have prohibitively large minimum investment sizes. The fund of funds manager spends considerable time and expertise evaluating strategies as well as selecting and monitoring underlying hedge funds.
Futures In finance, a futures contract is a standardised contract between two parties to buy or sell a specified asset of standardised quantity and quality at a specified future date at a price agreed today (the futures price).
Gearing Borrowing money to invest with the aim to increase returns. It can however also increase losses and is a higher risk strategy. Derivatives can also be used to gear a portfolio.
Government Bonds Bonds issued by governments or quasi-government institutions.
Gross Redemption Yield See yield.
Hedge Fund Typically invest in a variety of instruments, typically including short selling, leverage, derivatives, commodities and currencies. Normally targeting an absolute return strategy. Hedge funds theoretically take high risks in the hope of large rewards. Other typical features of hedge funds include performance-related fees and a substantial co-investment by the hedge fund manager.
High Yield High Yield strategies invest in sub-investment grade debt securities chiefly with the aims of making a positive carry and achieving capital appreciation. Such funds may take long and short positions, but in practice the norm is a significant long bias. The strategy will often depend on the performance of broader high yield and, to some extent, equity markets. Opportunities may be relative as well as absolute. For example, one type of debt instrument may be mis-priced relative to other debt of the same company. This could create an opportunity to take offsetting long and short positions.
High Yield Bond A speculative bond with a credit rating below investment grade.
Historic Yield The Historic Yield reflects distributions declared over the past twelve months as a percentage of the mid-market unit price, as at the date shown. It does not include any preliminary charge and investors may be subject to tax on their distributions.
Income Distribution The distribution of income to unit holders of pooled funds in proportion to the number of units held at the ex-dividend date.
Index-linked Bonds Both the interest payments (coupons) and the value of the eventual capital repayment for index-linked bonds are adjusted in line with the change in inflation, as measured by a pre-determined inflation measure. Investors are thus protected against the value of their investment being eroded by inflation.
Inflation A measure of the increase in prices of goods and services over time.
Information Ratio A measurement of risk adjusted performance. It measures performance added per unit of risk taken. It is the return of a fund in excess of its benchmark divided by the realised tracking error.
Investment Grade (Non-Investment) Bonds A bond is deemed to be 'investment grade' if it is rated BBB (Standard & Poor's)/Baa3 (Moody's) or above. These bonds typically provide the highest degree of principal and interest payment protection, and they are generally the least likely to default. The risk associated with the bond increases the lower rated it is from AAA downwards. Investment grade bonds are generally more appropriate for conservative clients.
Leverage Borrowing money to invest with the aim to increase returns. It can however also increase losses and is a higher risk strategy. Derivatives can also be used to for leverage.
Long/Short As a hedge fund strategy it represents an evolution of traditional long-only equity investment. Long-only strategies aim to buy undervalued securities, profiting when their prices rise. However, in long/short strategies they also aim to sell short overvalued securities. Long/short managers differ further from buy-and-hold investors by having the flexibility to use leverage as well as derivatives such as futures and options. By combining long and short positions, long/short equity hedge funds can reduce market risk as well as producing returns from falling stock prices.
Market Risk The risk that investments in a portfolio will not provide the returns expected due to underperformance of the chosen assets and markets.
Maturity End of the life of a fixed interest security at which point it is repaid. Also known as redemption. Maturity can also mean the end of the life of a future or option.
MiFID Markets in Financial Instruments Directive. MiFID is an EU Directive that came into force on 1 November 2007 across the European Economic Area (EEA). It aims to harmonise financial markets across the EU to create a consistent approach to the regulation of financial markets. MiFID brought about changes in scope, details and evidential requirements. Some of the key changes MiFID brought in are in the areas of client classification, best execution, suitability, inducements and conflicts of interest.
Modified Duration See duration.
Money Market Instruments Debt instruments such as Treasury bills or corporate paper with a maturity of less than one year, that are easily converted to cash.
Mutual Fund A pooled fund established under trust in which investors can buy and sell units on an ongoing basis. Known as mutual funds in the US and some other countries.
Option Adjusted Spread Of Fund Method used in calculating the relative value of a fixed-income security containing an embedded option, such as a borrower's option to prepay a loan.
Options In finance, an option is a contract between a buyer and a seller that gives the buyer of the option the right, but not the obligation, to buy or to sell a specified asset (underlying) on or before the option's expiration time, at an agreed price.
OTC (over the counter) contracts Trading that is transacted directly between counterparties, rather than through facilities provided by an exchange.
Overweight To hold more of a stock or sector than the index or benchmark against which the portfolio is measured. Opposite of underweight.
P/Book Value Price-to-book value (P/B) is the ratio of market price of a company's shares (share price) over its book value of equity. The book value of equity, in turn, is the value of a company's assets expressed on the balance sheet. This number is defined as the difference between the book value of assets and the book value of liabilities.
P/E Ratio Price/earnings ratio. A ratio used to value a company's shares. It is calculated by dividing the current market price by the earnings per share.
Par Value This is the face value of a security as opposed to its market value. In the case of a bond it represents the principal sum due on redemption.
Passive Management A style of investment management that seeks to attain performance equal to market or index returns. Compare with active management.
Predicted Tracking Error See Tracking Error.
Quartile See percentile.
Real Yield The yield on an investment, allowing for inflation.
Realised Tracking Error See Tracking Error.
Redemption The repayment of the principal sum outstanding on a bond. The date on which this occurs is the redemption date.
Redemption Yield See yield.
Return The value received (income plus capital) annually from an investment, usually expressed as a percentage. See also total return.
Return On Equity (ROE) A method of valuation of company accounts which can determine how well a company is spending its money to generate additional earnings. It is a useful comparison for companies in the same industry.
Rights Issue When existing shareholders are given rights to purchase the new shares in proportion to their existing holding.
Risk Risk is a measure of possibility of losing and not gaining value. It can often be defined as the standard deviation of the return on total investment. Degree of uncertainty of return on an asset.
Sharpe Ratio A measure of return over and above the risk free rate per unit of risk taken. It is a suitable measure for funds with an absolute return target, or for an investor's full range of investments.
Short selling The practice of selling assets, usually securities, that have been borrowed from a third party with the intention of buying identical assets back at a later date to return to the lender. The short seller hopes to profit from a decline in the price of the assets between the sale and the repurchase, as the seller will pay less to buy the assets than the seller received on selling them.
Spot market A market in which a commodity is bought or sold for immediate delivery or delivery in the very near future.
Standard Deviation A statistical measure of the historical volatility. More generally, a measure of the extent to which numbers are spread around their average.
Swaps In finance, a swap is a derivative in which two counterparties exchange certain benefits of one party's financial instrument for those of the other party's financial instrument. The swap agreement defines the dates when the cash flows are to be paid and the way they are calculated.
Total Return A combination of capital return and income return. The aggregate increase (or decrease) in the value of the portfolio resulting from the net appreciation (or depreciation) of the principal of the fund, plus the net income during the period. This is expressed as a percentage of the value of the fund at the start of the period.
Tracking Error A measure of how closely a portfolio follows the index to which it is benchmarked. If tracking error is measured historically, it is called 'realised' or 'ex post' tracking error. If a model is used to predict tracking error, it is called 'ex ante' or 'predicted' tracking error.
UCITS Undertakings for Collective Investments in Transferable Securities. UCITS funds are authorised funds that may be sold across all countries in the EU. UCITS III is the latest version of the UCITS regulations which enable funds to invest in a wider range of financial instruments, including derivatives. All UCITS funds converted to UCITS III by 13 February 2007. Most UK authorised funds are UCITS.
Underlying Yield The underlying yield reflects the annualised income net of expenses of the fund as a percentage of the mid-market unit price of the fund.
Underweight To hold less of a stock or sector than the index or benchmark against which the portfolio is measured. Opposite of overweight.
Volatility Volatility is a measure of the amount of fluctuation in an asset's (or market) price (level). For example, a stock with high volatility would have rapid up and down movements in its stock price. A stock with very little movement in its price would have low volatility.
Volatility or Standard Deviation is a measure of the variability of returns from their average return over a specified period of time, e.g. if the fund is valued monthly, then volatility is defined as the variability of the monthly returns from their average monthly return over a specified time period. High volatility (or annualised standard deviation) we multiply the standard deviation of the set of returns by the square root of the number of time intervals in a year e.g. 12 for monthly returns.
Warrant A certificate, usually issued along with a bond or share, that has a separate life and value. It entitles the holder to buy ordinary shares at a fixed price over a period of time, or to perpetuity. The price of the shares is usually higher than their market price at the time of issue. A warrant is freely transferable and can be traded separately.
Yield A measure of the income return earned on an investment. In the case of a share the yield expresses the annual dividend payment as a percentage of the market price of the share. For property, it is the rental income as a percentage of the capital value. For bonds the running yield (or flat or current yield) is the annual interest payable as a percentage of the current market price. The redemption yield (or yield to maturity) allows for any gain or loss of capital which will be realised at the maturity date.
Yield Spread The difference in yield between different types of bonds, for example between government bonds and corporate bonds.