Absolute Return Vehicles/Strategies

These are investment strategies aiming for positive return in absolute terms rather than relative to a benchmark

Active Fund Management

A style of investment management aiming to outperform a relevant benchmark.

Alpha

Risk-adjusted excess return active fund managers generate over their benchmarks.

Alternative Investments

For example: commodities, hedge funds, property and private equity. They are bought to enhance return and diversify a portfolio.

Annualised Return

The average return over a certain period rounded up or down to an annual figure. For example, if a fund has produced a return of 75% over five years, on average the fund would have produced a return of 11.8% each year.

Asset Allocation

Apportioning an investment portfolio among categories of assets, such as stocks, fixed income, property and precious metals.

Asset Class

The collective term for assets of a similar type.

Attribution Analysis

Breaking down the return achieved by a fund manager into its constituent parts (e.g. asset allocation and stock selection) to show where value was added.

Backwardation

A downwards sloping futures curve.

Balanced Fund

A fund invested in a range of asset classes.

Basis Point

1/100th of 1% (0.01%)

Bear

Someone who thinks the market, or a share, will decline. A bear market is when most prices are falling. Also used adjectively, as in ‘bearish’ and ‘bear market’.

Benchmark

An index or asset allocation that an investment strategy is measured against.

Benchmark Portfolio

Theoretical portfolio of benchmark assets that the performance of an actual portfolio is measured against.

Beta

Measures how sensitive a security or portfolio is against the market. A beta greater than 1.0 identifies an issue or fund that will move more than the market, while a beta less than 1.0 identifies an issue or fund that will move less than the market.

Bid-offer Spread

The difference between the price that an asset can be bought and sold.

Bond

A debt investment. A loan of money to an issuer, such as a company or a government. In exchange for the money, the issuer will pay you a pre-determined rate of interest (the coupon) and your capital (principal) back on specified dates.

Bottom-Up

An active investment management strategy that gives priority to the selection of companies (with less emphasis on sector and country selection) to build up an investment approach.

Bull

Someone who thinks the stock market or a particular stock share will go up. Also used adjectively, as in ‘bullish’, ‘bull market’.

Call Option

An option giving the buyer the right (but not the obligation) to buy a specified quantity of the underlying instrument at a fixed price, on or before a specified date.

Closed-End Fund

A collective investment vehicle that issues a fixed number of shares. To buy shares there must also be investors wishing to sell an equal number of shares. Shares in closed-ended funds are often dealt on a stock exchange.

Commodity

A raw material used in commerce that is interchangeable with others of the same type, e.g. gold, wheat, oil and copper.

Contango

An upward sloping futures curve.

Core portfolio

A portfolio generally representing the bulk of a fund’s assets.

Corporate

Often used as a generic term for all bonds except government bonds, although it should only apply to company (i.e. corporate) issues.

Credit Crunch

A sudden decline in the availability of credit or loans and an increase in the cost of financing.

Credit Rating

A rating of how much investment risk is associated with a bond issuer. The higher, or stronger, the rating, the more likely the issuer will be able to meet their interest (coupon) and capital (principal) repayment obligations in the future, and the lower the interest rate they need to offer in order to attract investors. Ratings are set by agencies such as Standard & Poor’s and Moody’s.

Credit Risk

The risk that a bond issuer will default on their obligations.

Currency Hedging

The process of eliminating/reducing foreign exchange risk when buying or holding foreign assets by entering off-setting transactions.

Currency Risk

The risk of incurring losses in the value of overseas investments as a result of movements in international exchange rates.

Cyclical Stocks

A security that is sensitive to movements in the economic cycle, i.e. generally performs well in periods of falling interest rates, or strong growth but poorly during an economic downturn, e.g. cars and housebuilders.

Default

Is the failure to pay interest or principal promptly when due, or to meet payments on a futures contract as required by an exchange.

Default Risk

The risk that an issuer will not be able to make future interest (coupon) or capital (principal) payments.

Defensive Stock

A stock that is expected to be less volatile than the overall market – for example the consumer staples sector.

Deflation

Negative inflation, i.e. a fall in general price levels, which typically sees an increase in the purchasing power of money.

Deleveraging

The process by which companies or individuals reduce their debt levels.

Depression

A severe and prolonged recession that is characterised by high levels of unemployment, widespread bankruptcies and shortage of credit.

Derivative

A financial instrument whose value is derived from, and determined by, the value of another security or benchmark, e.g. stock options, futures, interest rate swaps.

Devaluation

The formal reduction in the value of a currency against other currencies.

Discount Rate

Rate of interest used to convert a cash amount occurring in the future into a present value.

Disinflation

A reduction in the rate of inflation.

Diversification

A method of portfolio allocation and management aiming to balance risk and return by spreading investments among different securities or sectors to reduce the risk of owning any single investment.

Dividend

A discretionary payment from a company’s profits to its shareholders.

Dividend Yield

The return that the annual dividend of a share represents in relation to the current share price.

Downgrade

When a bond’s credit rating is lowered.

Earnings

The net profits of a company available for distribution to shareholders.

European Central Bank (ECB)

Responsible for setting monetary policy (interest rates) within the euro zone.

Efficient Frontier

A curve showing the highest expected return obtainable at each level of risk. Portfolios on the efficient frontier are considered optimal as they offer maximal expected return for a given level of risk as well as minimal risk for a given level of expected return.

Exchange Traded Fund (ETF)

A passive investment. Investors can ‘buy’ an index in the form of units which are actively traded on a stock exchange. The price of these units depends on the prevailing market price.

Financial Services Authority (FSA)

Regulates the financial industry in the United Kingdom.

Fiscal Policy

The management of the economy through government spending and taxation. Fiscal policy can be used to reflate or slow the economy. The government will tend to pursue reflationary policy when the economy is flagging and in need of stimulus. Conversely, when the economy is ‘overheating’, and in need of slowing down, deflationary policy might be needed.

Fixed-interest/Fixed-income securities

An interest paying security, where the interest is calculated as a constant specified percentage of the principal amount and paid at the end of specified interest periods, usually annually or semi-annually until maturity.

Forward

A contract in which two parties commit to the purchase and sale of a commodity or asset at some future time under such conditions as the two agree. Forwards are similar to futures. However, forwards are not exchange-traded.

Fund of Funds

Funds designed to achieve diversification and risk control by investing in other funds.

Fundamental Analysis

An assessment of a company’s share value and potential for future cash flows and profits based on accounting, economic and business information (i.e. fundamental information about the company).

Futures Contract

An agreement, traded on a financial exchange, to sell or buy a specific amount of a commodity or security at a specific price and time. Unless the contract is sold to another party before settlement date, participants in the contract are obliged to buy or sell the underlying asset.

Futures Curve

Plots all listed contracts for a commodity with delivery month on the x-axis against current price on the y-axis.

FTSE All-Share Index

A weighted arithmetic average of c. 750 securities traded on the London market which measures longer term movements in share prices.

FTSE 100 Index

A weighted arithmetic average of the 100 largest companies traded on the London market, as measured by market capitalisation.

FTSE 250 Index

Capitalisation-weighted index of the next 250 largest companies (after those that make up the FTSE 100) that are quoted on the London Stock Exchange. It covers medium sized companies.

Gearing (or Leverage)

The amount of a company’s total borrowings divided by its share capital. High gearing means a proportionately large amount of debt, which may be considered more risky for equity holders.

Gilt

Name given to bonds issued by the UK and Irish governments.

Hedge Fund

A fund that seeks to generate investment returns by using non traditional investment strategies, e.g. short selling, leverage programme trading, arbitrage and tools such as options, futures, swap and forwards.

Hedging

An operation to secure an investor against a potential loss, or minimise a potential risk by offsetting exposure by entering a position with the exact opposite pay-off pattern.

High Yield Bond

A bond whose issuer has a credit rating of BB+ or lower with Standard and Poors, or Ba1 or lower with Moody’s. They are also known as junk bonds or sub-investment grade bonds.

Index-Linked Gilt

A bond issued by the UK Government whose interest (coupon) and capital (principal) payments are adjusted to account for any changes in the UK Retails Prices Index.

Index Tracking

A passive management approach that mimics the investment performance of a specific market index.

Inflation

A measure of the rate of increase in general prices, e.g. the movement over time in the Retail Prices Index.

Initial Public Offering (IPO)

The first public sale of a company’s equity, resulting in a quoted stock price on a securities exchange.

Inter-bank Rates

The rates that banks bid for or offer funds to each other in a particular market.

Interest

The return earned on loaned or invested funds (i.e. the amount a borrower pays to a lender for the use of his/her money).

Investment Grade Bond

A bond whose issuer has a credit rating of BBB- or higher with S&P, or Baa or higher with Moody’s

Leverage (also the US term for gearing)

More than a 100% exposure to a market, or part of a market, typically resulting from the use of debt or derivatives (futures and options).

LIBID (London Interbank Bid Rate)

The rate at which major London banks offer to take funds from other banks.

LIBOR (London Interbank Offered Rate)

The rate at which major London banks offer to lend funds to other banks.

Liquidity

The ease with which buying and selling takes place in the market. Liquidity can be measured by the daily trading volume in a security.

Long

A market position where an investor has bought a position in excess of requirements of an index neutral weighting, usually with a view to selling it at a higher price.

Long/Short Fund

A hedge fund comprising a mixture of long and short positions in the same asset class or market.

Long-term

i. In the euro bond market, refers to initial maturities longer than seven years
ii. Under standard accounting practice, refers to long-term debt with a remaining maturity greater than one year.

Mandate

The agreement between a client and investment manager, on how the fund is to be managed

Market Neutral

A long/short fund with no net bias to the underlying market.

Market Risk/Systematic Risk

The risk common to an entire class of assets or liabilities. It is the level of risk in the market that cannot be removed by diversification.

Market Value

The price that an asset might reasonably be expected to be sold in an open market.

Maturity

i. The time period until the capital (principal) of a bond is due to be repaid.
ii. A reference to the age profile of a pension fund. A fund with a large proportion of pensioners is referred to as ‘mature’

Mean

An average amount or value.

Median

The value in a distribution of values, where 50% of the other values are bigger and 50% of the other values are smaller. In a symmetrical distribution, the mean and median are identical.

Medium-Term

i. In the euro bond market, refers to maturities of two to seven years.
ii. In the euro money markets, refers to maturities in excess of one year.

Money Market

The market for short-term fixed-income instruments. Examples include commercial paper, short-term debt and repurchase agreements.

Net Asset value (NAV)

The company’s assets less all liabilities; also known as shareholder funds.

OEIC

Open Ended Investment Company. A collective investment scheme structured as a limited company in which investors can buy and sell shares on an ongoing basis.

Open-ended Funds

Collective investment schemes where the number of units in the fund varies from day to day according to the number of investors wishing to buy or sell holdings in the fund.

Option

The buyer of an option has the right but not the obligation to buy (call) or sell (put) the underlying security at a pre-specified price in the future.

Outperformance

The excess return of a fund when compared to the return of its benchmark.

Overweight

Exposure to a specific asset (or asset class) that is higher than the proportion represented in the market index or benchmark against which the portfolio is measured.

Passive Management

A style of investment management that seeks to attain performance equal to market or index returns.

Put Option

An option that gives the buyer the right, but not the obligation, to sell a specified quantity of the underlying instrument at a fixed price, on or before a specified date.

Quantitative Easing (QE)

A tool of monetary policy used by the Bank of Japan (BoJ) in the 1990s in an attempt to kick-start the economy. With interest rates down to 0%, the BoJ turned to alternative policies to inject more liquidity into the system: it did this by buying government bonds. Towards the end of 2008, central bank rates around the world fell steeply towards 0%, influencing many central bankers to look at similar options.

Quartile

If a fund is ranked in the top 25% of funds available within its investment sector over the period shown, it is first quartile. Funds ranked in the next 25% are second quartile.

Real Rate of Return

Return adjusted for inflation.

Recession

A sustained economic slowdown, often defined by two consecutive quarters of economic contraction or negative growth.

Retail Prices Index (RPI)

The index published by the UK government used to measure the rate of inflation on standard goods and services.

Risk

Risk is the variability of returns. Investments with greater inherent risk must promise higher expected returns if investors are to invest in them. Risk is usually measured by the standard deviation of returns.

Roll Yield

Return generated when selling a futures contract. It is the difference between the price you paid and the amount you sold it for.

Running Yield

The annual income on an investment divided by its current market value, e.g. the dividend yield on equities.

S&P 500

Standard and Poor’s 500. It includes a representative sample of 500 leading companies in leading industries in the United States economy. Stocks in the index are chosen for market size, liquidity and industry group representation.

Sector

Stock markets are divided into sectors, which comprise companies from the same industries, e.g. telecommunications sector, oil sector etc.

Securitisation

The process of creating a tradable financial instrument by combining other non-tradable, usually loan-based assets.

Share

A stake in a company which confers ownership rights on the holder. Shares are also known as equities.

Sharpe Ratio

Measures how much fund performance is attributed to risk. The sharpe ratio is calculated as the average excess rate of return over the risk-free rate divided by the standard deviation of the excess returns. A sharpe ratio above 1 is good.

Short

A market position whereby the investor sells a security or market position which he does not own, or goes underweight relative to a benchmark, with a view to buying it back at a lower price at a later date.

Small-cap

Used to describe collectively those companies of small market capitalisation.

Sortino ratio

The Sortino ratio is similar to the Sharpe ratio except it only focuses on risk surrounding fund performance when it falls below a specified target or rate of return.

Sovereign Debt

Bonds issued by a central government.

Standard Deviation

A measure of volatility, often described as risk. The Standard Deviation measures the amount performance varies from its average. The larger the number, the more fund performance differs from its average, so the more volatility there is.

Strategic Asset Allocation

Long-term allocation of the assets in a portfolio among the main asset classes, with the aim of meeting the investor’s risk and return objectives.

Subprime

Refers to those borrowers deemed to represent higher risk to lenders due to a lack of visibility on their income/asset levels or due to poor credit ratings.

Swap

An instrument designed to permit investors to exchange payment streams for their mutual benefit. Payments can be based on a variety of factors including interest rates, currencies or equity returns.

Systematic Risk/Market Risk

The risk attributable to market or macro-economic factors which cannot be diversified away by stock selection, e.g. the impact of war on a domestic economy.

Tactical Asset Allocation

A method of allocating assets within a portfolio to take advantage of short-run expected changes in markets, sectors or instruments.

T-Bill (Treasury Bill)

A US government debt security with a maturity of less than one year.

Technical Analysis

The analysis of historical price movements and trends to predict future price action.

Top-down

An approach to investment analysis which starts from macro-economic factors (GDP growth, interest rates etc) and business cycle analysis to identify a portfolio distribution across asset classes, then progresses to a country/currency mix, a sector distribution and ultimately a stock selection.

Tracking error

A measure of the variability of investment returns relative to a benchmark or index. It is usually expressed as the annualised standard deviation of relative returns. Expressed as either ex-post, which is simply the historical tracking error, or ex-ante, which is a forward-looking estimate of the future tracking error.

Turnover

A measure of the level of trading in a market or portfolio. Usually expressed as the sum of the total value of purchases and sales in a period as a percentage of the portfolio value.

UCITS III

Undertakings for Collective Investments in Transferable Securities. UCITS is a European Union directive dating back to 1985 and governs how a fund can be marketed within the European Union. It is designed to allow cross-border fund sales to investors of different nationalities. In 2001, two further directives were adopted by the EU. Together the new directives provided for standardised and simplified fund prospectuses, as well as a wider range of investment powers.

Under UCITS III, funds are permitted to invest beyond the usual asset classes of equities and bonds. They can hold cash as an asset allocation tool and take advantage of derivative structures (such as those used by hedge funds), either to limit risk or increase return.

Underweight

Exposure to a specific asset (or asset class) which is lower than the proportion it represents in the benchmark against which the portfolio is measured.

Unit Trust

A open-ended, collective fund where new units are created for new investors and units are cashed in if the investor wants to leave the fund.

Value Investment/Style

An approach to investment that places emphasis on identifying shares that are believed to be underpriced (on the basis of indicators such as P/E ratio and dividend yield) by the market.

Volatility

The extent to which an asset’s price fluctuates, e.g. measured by the standard deviation of returns.

Weighting

Proportion of an index or portfolio made up of an individual or group of items, usually expressed as a percentage, e.g. the percentage of a portfolio invested in a region or in any one stock.

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. In the case of property, it is the rental income as a percentage of the capital value. In the case of a bond, the running yield (current yield) is the annual interest payable as a percentage of the current market price. The redemption yield (yield to maturity) allows for any gain or loss of capital which will be realised at the maturity date.