This guide has been created for you to help make investment literature easier to understand and to clarify some of the more common terms. Emphasis has been placed on clarity and brevity rather than attempting to cover every single complex detail.

As you read through, you will notice that some words are hyperlinked. This means that the word or phrase also has its own entry, and that you may need to look this up to gain a fuller understanding.

We hope you find the guide useful and simple to digest. We have made every effort to ensure that the terms are accurately described, however, the descriptions are not definitive and they may differ from
other interpretations used.

A

Absolute return strategy

An absolute return investment strategy aims to deliver positive returns whatever the market does, rather than simply aiming to outperform a benchmark index.

Accumulation units

Units in a collective investment scheme where any income is automatically reinvested into the scheme. See also income units.

Active management

An investment management approach where a manager aims to beat the market through research, analysis and their own judgement. See also Passive management.

Active risk

To try to beat the returns of the benchmark the active investment manager must take different investment positions to the benchmark. Where positions are different, risks are also different. The risk that the manager takes relative to the risk of the benchmark is known as active risk. The higher the level of active risk, the greater the chance that returns will deviate from the benchmark.

Alpha

A measure which can help you identify whether an actively managed portfolio has added value in relation to risk taken relative to a benchmark index. A positive Alpha indicates that a manager has added value.

Alternative investments

Investments outside of the traditional asset classes of equities, bonds and cash. Alternative investments include property, hedge funds, commodities, private equity, and infrastructure.

Annualised return

For a period of greater than one year, a measure of the level of return that has been achieved on average each year.

Asset-backed security (ABS)

An investment that derives its value and income payments from a pool of illiquid (see liquidity). This allows investors access to a diversified pool of assets that they would not otherwise be able to buy, for example loan repayments.

Asset class

Broad groups of different types of investments. The main investment asset classes are equities, bonds and cash. Non traditional asset classes are known as alternative investments.

Benchmark

A standard, (usually an index or a market average) that an investment fund's performance can be measured against. Many funds are managed with reference to a stated benchmark.

Bid price

The price a buyer is willing to pay. In the context of funds, it is the price received by the investor when redeeming a share or a unit in a dual priced fund. See also offer price.

Bonds

Provide a way for governments and companies to raise money from investors for current spending requirements. In exchange for an upfront payment from investors, a bond will typically commit the issuer to make annual interest payments and to repay the initial investment amount on maturity at a specified date in the future.

Bottom up investing

Investment based on analysis of individual companies, whereby that company's history, management, and potential are considered more important than general market or sector trends (as opposed to top down investing).

C

Capital discipline

Where a company exercises discipline and prudence in how much money it borrows, raises and spends, in order to deliver the best returns to its shareholders and ensure its long-term stability.

Collective Investment Scheme (CIS)

A professionally managed fund which combines the money of a broad range of investors in a single investment vehicle. This pools costs and allows access to a wider range of investments than investors would generally be able to achieve individually.

Corporate bond

A bond issued by a company.

Correlation

Correlation is a measure of how securities or asset classes move in relation to each other. Highly correlated investments tend to move up and down together while investments with low correlation tend to perform in different ways in different market conditions, providing investors with diversification benefits. Correlation is measured between 1 (perfect correlation) and -1 (perfect opposite correlation). A correlation coefficient of 0 suggests there is no correlation.

Coupon

The regular interest payment paid on a bond. It is described as a percentage of the face value of an investment. So a bond with a face value of £100 with a 5% coupon will pay £5 a year.

Credit default swap (CDS)

A CDS is a derivative. It is a type of insurance against the default of debt. The buyer of a CDS pays a premium to a CDS seller in exchange for the insurance that if the debt defaults, the CDS seller will pay it to them. The CDS seller is speculating against the risk of default and hopes to make a profit from the premium payments. The higher the risk of default, the higher the premium.

Credit Rating

Bond issuers can pay to have their bonds rated by a number of credit ratings agencies including Standard & Poors, Moody's and Fitch. The credit rating is designed to give investors an indication of the quality of the bond, providing a professional assessment of the risk that the issuer may default on interest and capital repayments. Credit ratings are subject to regular review and can and do change.

Credit Risk

The risk that a bond issuer will default on their contractual obligation to make interest payment to investors.

Currency Hedging

Reducing or removing the risk of incurring losses through currency movements. This is typically achieved through the use of derivatives such as futures or options.

Current Yield

The annual income from an investment, expressed as a percentage of the current price. For example, if a bond that is worth £100 gives you an annual income of £6, the current yield is 6%.

D

Default risk

The risk that a bond issuer will not be able to meet their debt payments and subsequently default on their contractual obligation to investors.

Derivatives

The collective name used for a broad class of financial instruments that derive their value from other underlying financial instruments. Futures, options and swaps are all types of derivative.

Distribution Yield

Reflects the amounts that may be expected to be distributed over the next 12 months as a percentage of the mid market price of the fund as at the date shown. It is based on a snapshot of the fund on that day. It does not include any preliminary charge and investors may be subject to tax on the distribution.

Diversification

Creating a portfolio from a range of different assets. This reduces the risk of loss through exposure to any individual asset and can help to reduce overall portfolio risk where assets have a low correlation.

Dividend yield

The annual dividend per share divided by the current share price. It is useful for comparing investments. For example, if a company's shares are trading at £100 and the annual dividend is £5, the dividend yield is 5%. However, if the company's shares are £200, the dividend yield is just 2.5%.

Draw down

A draw down is usually quoted as the percentage between the peak and trough of an investment during a specific period. It can help to compare an investment's possible reward to its risk. Alternatively, when investing in certain types of funds, particularly venture capital funds, it can also refer to when an investor commits to invest a sum of money but doesn't give it all to the fund manager immediately. The fund manager makes the investments and draws down money as required.

Duration

A measure of a bond investment's sensitivity to changes in interest rates. The longer the duration, the more sensitive it is. Calculating 'duration' for a fixed income investment such as a bond is a complicated sum. It takes into account the current value of the bond, the coupon or interest payment, the book cost, and the number of years the bond has left to run. Put simply, the higher the duration number the higher the potential return (and the greater the risk).

Earnings growth

The percentage change in a company's earnings per share, generally measured over one year.

Earnings yield

The earnings per share divided by the current market price.

Emerging markets

Countries that have rapidly growing economies and may be going through the process of industrialisation.

Ex Ante (Tracking error)

Tracking Error is a measure of how closely an investment portfolio follows the index against which it is benchmarked. If a model is used to predict this (rather than it being measured historically) it is called ex ante or predicted. See also ex post.

Ex post (Tracking error)

Tracking Error is a measure of how closely an investment portfolio follows the index against which it is benchmarked. If the tracking error is measured historically it is called ex post or realised tracking error. See also ex ante.

F

Flat yield

When short-term and long-term bonds are offering equivalent yields.

Frontier markets

Less developed countries within the emerging markets. Investments in these countries may be associated with higher risks, such as increased political instability and lower liquidity, than more developed markets.

Fund of hedge funds

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.

Futures

An agreement to buy or sell an asset such as a bond or equity, on a specific date in the future at a price agreed today.

G

Gearing

Borrowing money to invest, with the aim of increasing returns. For example, if you invest £100 and make a 5% return you make £5. Borrow an extra £20 to invest and you make £6 (minus the cost of borrowing the money). However, with gearing comes a higher degree of risk. Whilst the potential for growth may be greater; losses may be more substantial too. Derivatives such as futures or options can also be used to gear an investment portfolio. A small movement in the price of an underlying asset can make a large difference to the value of a derivative, and dramatically increase the returns. Also known as leverage.

Government bonds

A bond issued by a government.

Gross redemption yield

The total return you could receive on a bond including the interest or coupon plus any capital growth.

H

Hedge fund

A collective name for funds targeting absolute returns through investment in financial markets and/or applying non-traditional portfolio management techniques. Hedge funds can invest using a broad array of strategies, ranging from conservative to aggressive.

High yield bond

A speculative bond with a credit rating below investment grade. Generally, the higher the risk of default by the bond issuer, the greater the interest or coupon.

Historic yield

The distributions declared over the past 12 months expressed as a percentage of the mid-market price, as at the date shown. It does not include any preliminary charge and investors may be subject to tax on the distribution. So, for example, if a bond has paid £10 over the last year, and the current price is £100, the historic yield is 10%.

I

Income distribution

The distribution of income to unit holders of pooled funds in proportion to the number of units held.

Income units

A holding in a pooled fund that pays out interest or dividends to investors, rather than re-investing them back into the fund. See also Accumulation units.

Index-linked bonds

Bonds where coupon and capital payments are linked to movements in inflation. The inflation measure used is specified beforehand.

Information ratio

A measure of how well a manager has performed relative to the level of risk they have taken.

Intrest rate swap

A type of swap. The most common form of interest rate swap is where one party pays a fixed rate of interest in return for a floating rate.

Investment grade bonds

The highest quality bonds as assessed by a credit ratings agency. To be deemed investment grade, a bond must have a credit rating of at least BBB (Standard& Poor's) or Baa3 (Moody's).

Investment trust

An investment trust is a closed ended collective investment scheme with a limited number of shares that pools together assets of a number of different investors with the aim of increasing flexibility and lowering costs. They are companies that trade in their own right which means that the price of the shares are subject to supply and demand. Unlike an open ended fund, the manager does not have to deal with fund flows and therefore never a forced seller/buyer.

ISA (Individual Savings Account)

An ISA is basically a type of tax-free savings account. There are two main types, a Cash ISA and a Stocks and Shares ISA. You can put money into a Cash ISA and you don't pay tax on any interest you receive. Invest in a Stock and Shares ISA, and you don't pay tax on any further dividends or capital gains.

K

Large cap

See Market Capitalisation.

Leverage (gearing)

Leverage usually refers to a fund being exposed by more than 100% of its net asset value to assets or markets. The aim may be to take on more risk in order to generate higher returns, or it may actually be to reduce risk in the portfolio. It is achieved by combining derivatives with more traditional equity or bond investments. Confusingly, leverage can also be used to refer to the amount a company is funded through borrowing, i.e. how much money it owes compared to how much money or assets it owns. This is also described as 'gearing'.

Long/short strategy

A strategy, used primarily by hedge funds, that involves taking long positions (buying a holding) in stocks that are expected to increase in value and short positions (borrowing a stock you don't own and selling it in the hope of repurchasing it at a lower price to return to the stock lender) in stocks that are expected to decrease in value.

M

Market capitalisation

A measure of a company's size, calculated by multiplying the total number of shares in issue by the current share price. Companies are commonly grouped according to size as small cap, mid cap or large cap. There is no consensus on the monetary boundaries of these ranges but as a rough guide in the US market: large cap is over $10 billion, mid cap is $2 billion–$10 billion and small cap is $250 million–$2 billion.

Maturity

The date when the original amount invested in a bond is repaid. Maturity can also mean the end of the life of a future or option.

Mid cap

See also Market Capitalisation.

Modified duration

A formula to determine the approximate percentage change in the value of a bond in response to a 1% change in interest rates. See also duration.

Mortgage-backed security (MBS)

Similar to an (see) asset-backed security, this is a security that pools mortgage repayments to effectively allow investment markets to lend to homeowners or businesses through financial institutions, who may not be willing to take on the risk of issuing mortgages themselves.

Mutual fund

A professionally managed collective investment scheme that pools money from a large number of investors.

N

NURS

Non-UCITS Retail Schemes (NURS) are funds set up and managed in accordance with FCA regulations for such schemes. NURS rules allow funds to access additional asset classes over and above UCITS.

O

OEIC

An Open Ended Investment Company is a type of collective investment scheme. It is open ended, so the number of shares in the fund goes up as money is put in and goes down as it is taken out.

Offer price

The price a seller is willing to accept for the sale of a security. In the context of funds, it is the price paid by the investor when buying a share or a unit in a dual priced fund. See also bid price.

Option adjusted spread of fund

A way of calculating the value of a fixed-income security, such as a bond, that contains an embedded option. For example, when the bond issuer has the option to repay a loan early, that is an embedded option and it will affect the value of the bond.

Open-end

This refers to a pooled investment vehicle, such as a unit trust or OEIC that can issue unlimited numbers of units or shares. This means the number of units or shares in the fund goes up as money is put in and goes down as it is taken out.

Options

When you buy an option, you have the right (but not the obligation) to buy a particular asset at an agreed price, on or before the date when your option expires.

OTC (over the counter) contracts

Trading of equities, bonds,commodities or derivatives directly between two parties, rather than through an exchange.

Overweight

When a portfolio or fund has a greater percentage weighting in an asset class, sector, geographical region or stock than the index or benchmark against which it is measured.

P

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 maturity.

Passive management

A style of investment management that aims to replicate the performance of a set benchmark. See also active management.

PEP (Personal Equity Plan)

A PEP was a type of tax-free savings account, similar to a Stocks and Shares ISA. You can no longer open a PEP and, in April 2008, all remaining PEPs were converted into Stocks and Shares ISAs.

Predicted tracking error

Tracking Error is a measure of how closely an investment portfolio follows the index against which it is benchmarked. If a model is used to predict this (rather than it being measured historically) it is called predicted or ex ante. See also realised tracking error.

Price-to-book value

The ratio used to compare a company's share price with its book value (the book value is the actual value of the company assets minus its liabilities).

Private equity

Equity securities of companies that are not listed on a public exchange. Transfer of private equity is strictly regulated; therefore, any investor looking to sell his/her stake in a private company has to find a buyer in the absence of a marketplace.

Q

Real Return

The return generated by an investment, having been adjusted for the effects of inflation. If an investment grew in value by 5% return over one year, and the rate of inflation was 2%, the real return would be 3%.

Realised tracking error

Tracking Error is a measure of how closely an investment portfolio follows the index against which it is benchmarked. If the tracking error is measured historically it is called realised or ex post. See also predicted tracking error.

Redemption

The repayment of the principal sum at maturity of an investment.

Redemption yield

The yield is the return earned on a bond. The redemption yield allows for any gain or loss of the original capital, which is paid back on the date of maturity. The return on a bond if it is held to its maturity date, reflecting not only the interest payments a bondholder will receive, but also the gain/loss made when it matures. Yield calculations on bonds aim to show the return as a percentage of either its nominal value or its current price.

Rights Issue

When existing shareholders are given the right to purchase new shares in a company within a given period, in proportion to their existing holding, at a given price (usually at a discount).

Risk premium (plural: premia)

The extra return over cash that an investor expects to earn as compensation for owning an investment that is not risk free, so its value could go down as well as up. There are some risk premia where the extra return expected is over and above the return earned from another risk premium. For example, the small company share risk premium is the extra return an investor expects to receive over and above the return from large company shares as compensation for investing in higher risk small companies.

S

Security

General term for an equity or debt instrument issued by a government or company.

Short selling (also referred to as shorting, taking a short position, going short)

Selling assets that you have borrowed from a third party, and then buying them 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.

Small cap

Small cap See Market Capitalisation.

Swaps

A derivative in which two parties exchange certain benefits of each other's financial instruments. These are traded over the counter (otc).

Top-down investing

an investment strategy which finds the best sectors or industries to invest in, based on analysis of the corporate sector as a whole and general economic trends (as opposed to bottom up investing).

Total Expense Ratio (TER)

The total fees involved in managing and operating a fund. The TER included the annual management fee and other charges, for example legal, admin, and audit costs. Following the introduction of KIIDs, TERs have been replaced with OCFs.

Total return

The total return on an investment, including any capital appreciation (or depreciation) plus any income from interest or dividends. It is measured over a set period, and is given as a percentage of the value of the investment at the start of that period.

Tracking error

A measure of how closely an investment portfolio follows the index against which it is benchmarked. See also predicted tracking error, realised tracking error, ex ante and ex post.

U

UCITS (Undertakings for Collective Investments in Transferable Securities)

UCITS funds are authorised funds that can be sold in any country in the EU. UCITS III regulations allow funds to invest in a wider range of financial instruments, including derivatives.

Underweight

When a portfolio or fund has a lower percentage weighting in an asset class, sector, geographical region or stock than the index or benchmark against which it is measured.

Unit trust

A type of open-ended pooled investment vehicle, or fund, which is structured as a trust.

V

Volatility

A statistical measure of the fluctuations of a security's price. It can also be used to describe fluctuations in a particular market. High volatility is an indication of higher risk.

W

Yield

A measure of the income return earned on an investment. In the case of a share, the yield is the annual dividend payment expressed 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 yield is the annual interest as a percentage of the current market price.

Yield spread

The difference in yield between different types of bonds (for example, between government bonds and corporate bonds).

Yield to maturity

The rate of return anticipated on a bond if it is held until the maturity date.