GLOSSARY
ABS
An asset-backed security is a financial security backed by a loan, lease or receivables against assets other than real estate and mortgage-backed securities.
Absolute return
Absolute return investing aims to achieve positive returns over a medium term not correlated to traditional asset classes such as equity and fixed income. Funds managed with this approach have no benchmark constraints and do not use a benchmark to measure their returns. An absolute return fund seeks to generate positive returns by employing investment management techniques that differ from traditional mutual funds and include derivative instruments and leverage.
Active management
Refers to the use of a human element – such as a single manager, co-managers, or a team of managers – to actively manage a fund’s portfolio. Active managers rely on analytical research, forecasts and their own judgment and experience in making investment decisions on what securities to buy, hold and sell. The opposite of active management is called passive management, better known as indexing.
Alpha
A measure of performance on a risk-adjusted basis. Alpha takes the volatility of a mutual fund and compares its risk-adjusted performance to a benchmark index. The excess return of the fund relative to the return of the benchmark index is a fund’s alpha.
Asset management
The business of managing third party (and other) financial investments.
Benchmark
An index that represents a market or a sector, against which a fund measures its performance. Funds typically compare their performance against indices such as the FTSE 100 or the S&P 500.
Beta
A measure of a fund’s sensitivity to market movements. The beta of the market is 1.00 by definition. A beta of 1.10 shows that the fund has performed 10% better than its benchmark index in up markets and 10% worse in down markets, assuming all other factors remain constant. Conversely, a beta of 0.85 indicates that the fund is expected to perform 15% worse than the market’s excess return during up markets and 15% better during down markets.
Blue chip
Blue chips are shares in a large, reliable well-managed company with a strong credit rating.
Bond
Debt investment in which an investor loans money to an entity (corporate or governmental) that borrows the funds for a defined period of time at a fixed interest rate. Bonds are used by companies, municipalities, states and U.S. and foreign governments to finance a variety of projects and activities. Bonds are commonly referred to as fixed-income securities and are one of the three main asset classes, along with stocks and cash equivalents.
The indebted entity (issuer) issues a bond that states the interest rate (coupon) that will be paid and when the loaned funds (bond principal) are to be returned (maturity date). Two features of a bond – credit quality and duration – are the principal determinants of a bond’s interest rate.
Bond Funds
A bond fund is a mutual fund that invests in bonds and other debt securities. Bond funds yield monthly dividends that include interest payments on the fund’s underlying securities plus any capital appreciation in the prices of the portfolio’s bonds.
Bottom up
An investment approach that de-emphasizes the significance of economic and market cycles. This approach focuses on the analysis of individual stocks. In bottom-up investing, therefore, the investor focuses his or her attention on a specific company rather than on the industry in which that company operates or on the economy as a whole. Opposite of top down.
Collateralized debt obligation (CDO)
An investment-grade security backed by a pool of bonds, loans and other assets. CDOs do not specialize in one type of debt but are often non-mortgage loans or bonds.
Convertible bond
It is a type of bond that can be converted into shares of stock of the issuing company, usually at some pre-announced ratio. Although it typically has a low coupon rate, the holder is compensated with the ability to convert the bond to common stock, usually at a substantial premium to the stock’s market value.
Corporate bond
A corporate bond is a bond issued by a corporation. The term is usually applied to longer-term debt instruments, generally with a maturity date falling at least a year after their issue date.
Correlation
A statistical measure of how two securities move in relation to each other.
Country risk
Country risk refers to the likelihood that change in the business environment adversely affects operating profits or the value of assets in a specific country.
Coupon
A coupon is the interest rate that the issuer pays to the bond holders.
Credit rating
One of the principal criteria for judging the investment quality of a bond or bond mutual fund. As the term implies, credit quality informs investors of a bond or bond portfolio’s creditworthiness, or risk of default
An individual bond or bond mutual fund’s credit quality is determined by private independent rating agencies such as Standard & Poor’s, Moody’s and Fitch. Their credit quality designations rang from high (‘AAA’ to ‘AA’) to medium (‘A’ to ‘BBB’) to low (‘BB’, ‘B’, ‘CCC’, ‘CC’ to ‘C’).
Investors interested in the safety of their bond investments should stick to investment grade bonds (‘AAA’, ‘AA’, ‘A’, and ‘BBB’), while other investors willing and able to accept a higher level of risk could consider lower credit-quality bonds.
Derivative instrument
A generic expression for securities whose prices are based on the prices of another underlying investment. Types of derivatives include futures, options, swaps and warrants.
Duration
The average time to payment. Also a measure of the effect of interest rate changes on the price of a fixed income asset or portfolio. Duration is defined in years (that is a three year duration means the value of the bond could rise about 3% if interest rates fall by 1%).
ESG (Environmental, Social & Governance)
Environmental, Social and Governance (ESG) Criteria are a set of standards for a company’s operations that socially conscious investors use to screen potential investments. Environmental criteria look at how a company performs as a steward of the natural environment. Social criteria examine how a company manages relationships with its employees, suppliers, customers and the communities where it operates. Governance deals with a company’s leadership, executive pay, audits, internal controls and shareholder rights.
EONIA
Eonia (Euro OverNight Index Average) is an effective overnight rate computed as a weighted average of all overnight unsecured lending transactions in the interbank market. It has been initiated within the euro area by the contributing panel banks. It is one of the two benchmarks for the money and capital markets in the euro zone (the other one being Euribor).
Equity
A stock or any other security representing an ownership interest.
Equity fund
A mutual fund whose portfolio consists primarily of common stocks.
EURIBOR
The Euro Interbank Offered Rate (or Euribor) is a daily reference rate based on the averaged interest rates at which banks offer to lend unsecured funds to other banks in the euro wholesale money market (or interbank market).
Front-end load
A front-end load is a commission or fee charged when shares of a mutual fund are bought. On the day of the acquisition, the front-end load is added to the real bid price, thus generating the offering price.
Fundamental analysis
Fundamental analysis is a type of analysis carried out on a company involves analyzing its income statement, financial statements and health, its management and competitive advantages, and its competitors and markets.
Funds of Funds
Funds of funds (FoF) are mutual funds which invest in other underlying mutual funds (i.e., they are funds comprised of other funds).
Future
A future is an agreement to buy or sell goods, currency or securities on an agreed future date and for a price fixed in advance.
Growth
Refers to an investment strategy that selects shares with a record of past growth and the potential for future increases in capital value. Usually, that means companies with high growth in earnings or expected earnings, and hence the potential for big increases in the stock price.
High Yield
A high paying bond with a lower credit rating than investment-grade corporate bonds, Treasury bonds and municipal bonds. Because of the higher risk of default, these bonds pay a higher yield than investment grade bonds. Based on the two main credit rating agencies, high-yield bonds carry a rating of ‘BBB’ or lower from S&P, and ‘Baa’ or lower from Moody’s. Bonds with ratings above these levels are considered investment grade. Credit ratings can be as low as ‘D’ (currently in default), and most bonds with ‘C’ ratings or lower carry a high risk of default; to compensate for this risk, yields will typically be very high.
Information ratio
The Information Ratio measures the excess return of an investment manager divided by the amount of risk the manager takes relative to a benchmark.
Interest Rate Swap
An interest rate swap is a derivative in which one party exchanges a stream of interest payments for another party’s stream of cash flows. Interest rate swaps can be used by hedgers to manage their fixed or floating assets and liabilities. They can also be used by speculators to replicate unfunded bond exposures to profit from changes in interest rates. As such, interest rate swaps are very popular and highly liquid instruments.
Investment grade
A bond is considered investment grade if its credit rating is BBB- or higher by Standard & Poor’s or Baa3 or higher by Moody’s or BBB(low).
Liability Driven Investment (LDI)
Liability driven investment (LDI) is primarily applied to gain sufficient assets to cover all liabilities, both present obligations and those that will be accrued in the future. This type of investing is common when dealing with insurance contracts or defined-benefit pension plans.
Market capitalization
Market capitalization, or market cap, is a measurement of corporate or economic size equal to the share price times the number of shares outstanding of a public company.
Market timing
An investment strategy in which investors switch in and out of securities or between types of funds in the hopes of benefiting from various economic and technical indicators that are thought to presage market moves.
Maturity
The date on which the principal of a debt instrument, i.e. a bond, is due to be paid.
Money market fund
Mutual fund, which exclusively or mainly invests in money market securities and liquid securities with short maturities. Among the money market instruments are time deposits, loans and bonds with short-term maturities as well as Commercial Papers and deposits with banks (Certificates of Deposit). Their advantage over time deposits or savings deposits is that the one is not bound to certain periods of 30, 60 or 90 days, but have access to one’s money anytime.
Mutual fund
A mutual fund is a professionally-managed form of collective investments that pools money from many investors and invests it in stocks, bonds, short-term money market instruments, and/or other securities. Mutual funds can invest in many different kinds of securities, the most common are money market, equities and bonds.
Net Asset Value (NAV)
The value of the investments in a fund. In the case of a unit trust or OEIC the net asset value per share normally corresponds to the fund’s market price, subject to any sales or exit charge.
Passive management
Passive management (also called passive investing) is a financial strategy in which a fund manager makes as few portfolio decisions as possible, in order to minimize transaction costs, including the incidence of capital gains tax. One popular method is to mimic the performance of an externally specified index?called ‘index funds’.
Performance fee
A payment awarded to a fund manager if certain performance levels are attained in a set period of time. Often, it refers to the achievement of a return on a fund over and above the investment objective.
Rating (Please also see Credit Rating)
Grade given to bonds that indicates their credit quality. Private independent rating services such as Standard & Poor’s, Moody’s and Fitch provide these evaluations of a bond issuer’s financial strength, or its ability to pay a bond’s principal and interest in a timely fashion.
Bond ratings are expressed as letters ranging from ‘AAA’, which is the highest grade, to ‘C’ (“Junk”), which is the lowest grade. Different rating services use the same letter grades, but use various combinations of upper- and lower-case letters to differentiate themselves.
To illustrate the bond ratings and their meaning, we’ll use the Standard & Poor’s format:
AAA and AA: High credit-quality investment grade AA and BBB: Medium credit-quality investment grade BB, B, CCC, CC, C: Low credit-quality (non-investment grade), or “junk bonds” D: Bonds in default for non-payment of principal and/or interest
Risk Adjusted return
A measure of how much risk a fund or portfolio takes on to earn its returns, usually expressed as a number or a rating.
Sharpe Ratio
A risk-adjusted measure developed by Nobel Laureate William Sharpe. It is calculated by using standard deviation and excess return to determine reward per unit of risk. The higher the Sharpe Ratio, the better the fund’s historical risk-adjusted performance.
SICAV Funds
A SICAV is an open-ended collective investment scheme especially common in Luxembourg, Switzerland, Italy and France. SICAV is an acronym for Société d’investissement à capital variable which can be translated as investment company with variable capital. As in the case of other open-end collective investment schemes (such as contractual funds), the investor is in principle entitled at all times to request the redemption of his units and payment of the redemption amount in cash.
Socially Responsible Investment (SRI)
An investment that is considered socially responsible because of the nature of the business the company conducts. Common themes for socially responsible investments include avoiding investment in companies that produce or sell addictive substances (like alcohol, gambling and tobacco) and seeking out companies engaged in social justice, environmental sustainability and alternative energy/clean technology efforts. Socially responsible investments can be made e.g. through a socially conscious investment fund.
Standard deviation
Standard deviation of fund returns measures how much a fund’s total returns have fluctuated in the past. The term volatility is often used to mean standard deviation. The more a fund’s return fluctuates, the riskier the fund is likely to be.
Strategic asset allocation (SAA)
A portfolio strategy that involves periodically rebalancing the portfolio in order to maintain a long-term goal for asset allocation
Subprime mortgage
A type of mortgage that is normally made out to borrowers with lower credit ratings. As a result of the borrower’s lowered credit rating, a conventional mortgage is not offered because the lender views the borrower as having a larger-than-average risk of defaulting on the loan. Lending institutions often charge interest on subprime mortgages at a rate that is higher than a conventional mortgage in order to compensate themselves for carrying more risk.
Swap
A swap is a derivative in which two counterparties agree to exchange one stream of cash flows against another stream.
Tactical Asset Allocation (TAA)
An active management portfolio strategy that rebalances the percentage of assets held in various categories in order to take advantage of market pricing anomalies or strong market sectors
Total Expense Ratio (TER)
The Total Expense Ratio, or TER, is measuring the total costs of a fund investment. Total costs may include various fees (trading, auditing) and other expenses. The TER is calculated by dividing the total cost by the fund’s total assets and is denoted as a percentage. It may vary from year to year.
Tracking Error
The volatility of the difference in returns between a fund and its benchmark, also known as active risk. In the context of passive management (tracker fund), tracking error properly describes how well a fund tracks its benchmark. But in relation to active management it is a misnomer: It describes how far the fund manager has strayed from its benchmark, not an error. The measure is nevertheless useful in performance assessment: the higher the active return (outperformance) in relation to the active risk (tracking error) the better.
Value
An investment strategy that selects shares that are attractively priced, relative to the earnings or the internal value of the company – or, in some cases, relative to the market. The theory is that the share price of these companies will eventually rise to reflect the true value.
Value at Risk (VaR)
Value at Risk indicates the maximum loss of a portfolio over a given period of time. It is calculated with a given probability (named confidence level) on the base of the statistical analysis of historical price trends and volatilities.
Volatility
Volatility is the observed price movement of an asset. Standard deviation is the most widely used measure of volatility. Volatility and standard deviation are generally considered to be a measure of risk.
Yield
The rate of return, expressed as a percentage, paid on an investment – in the form of dividends for stocks and funds or the coupon rate for bonds.
Yield curve
Depicts the relationship between a bond’s maturity and its yield. The yield curve usually refers to this relation for government bonds. Whilst the curve is often sloping upwards (i.e. higher yields for longer maturities), it is not unusual to observe other shapes (inverted, U-shaped, etc…).
Yield to maturity
The rate that is used to discount future coupon and principal payments to obtain the market price of the bond. A high yield means a low price – the bond is cheap – and a low yield means a high price – the bond is expensive.
Zero Coupon Bond
A fixed income investment that is issued at a discount to its face value but pays no coupons (interest) through its life. For example, an investor could pay 900 €, receive no annual payments for five years, but get 1.000 € when the bond matures.
