Glossary

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A

ABCP

Asset Backed Commercial Paper is a short-term investment vehicle with a maturity that is typically between 90 and 180 days. The security itself is generally issued by a bank or other financial institution. The notes are backed by physical assets such as trade receivables, and are generally used for short-term financing needs.

Accumulating NAV

Accumulating NAV funds operate under the same investment guidelines as constant NAV funds and income is accrued daily. However, unlike constant NAV funds, income is not distributed. Instead income is reflected by an increase in the value of the fund shares and realised upon redemption of those shares at higher price.

Agency Bond

A bond issued by a government agency e.g. Fannie Mae and Freddie Mac.

Amortisation

Amortisation of securities involves taking the difference between the purchase price and the maturity price and spreading that difference equally each day until the holding matures. The effect is similar to accrued interest on a bond, where daily accruals can be calculated in advance. The amortising component of the security is treated as income whilst the principal remains unchanged. Applying this method to all securities within the money market fund allows for stable NAV share classes that distribute income.

AUM

Assets Under Management (AUM), in general, refer to the market value an investment company manages on behalf of investors.

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B

Basis point

1/100th of 1% (0.01%).

BBA

British Bankers’ Association (BBA) is the leading trade association that represents the views of those involved in the banking and financial services industry within the UK. It is the BBA’s responsibility to set benchmark rates such as LIBOR.

Bear

Someone who thinks the market, or a particular share, will decline. A bear market is one in which most prices are falling. Also used adjectivally, as in 'bearish', 'bear market' and so on.

Benchmark

A standard asset allocation against which an investment strategy is measured.

Benchmark portfolio

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

Beta

The sensitivity of an asset's or portfolio's return to fluctuations in the return of the market or benchmark. If beta is greater than 1.0 the asset or portfolio will move more than the market or benchmark, while if it is less than 1.0 it will move less.

Bond

A 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 rate. Bonds are commonly referred to as fixed-income securities.

Bottom-up

An approach to active investment management that gives priority to the selection of companies (with less emphasis on sector and country selection) to build up an investment portfolio. This is the opposite of a top-down approach.

Bull

Someone who thinks the stock market or a particular share will go up. Also used adjectivally, as in 'bullish', 'bull market' and so on.

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C

CD

A short-term, non-interest bearing bond issued by banks and building societies. CDs have a secondary market; the holder of a CD is often able to sell it to a third party in order to realise cash before the maturity date of the CD.

Collateral

Assets put up as security to protect a lender in case the borrower defaults.

Constant NAV

Constant (or stable) NAV money market funds are issued with an unchanging face value. Income is accrued daily and can either be paid out to the investor or used to purchase more units in the fund.

Contract note

Written confirmation of the purchase or sale of an investment.

Coupon

The regular interest payments on a bond.

CP

Commercial Paper (CP) are short-term securities, issued by banks and large corporates. CP is issued at a discount with zero coupon.

Credit rating

A rating of how much investment risk is associated with a debt issue. Ratings are provided by agencies such as Fitch, Moody's and Standard & Poors.

Credit risk

The risk that a bond issuer will default on their obligations. A function of the credit quality of the issuer. Government bonds of developed countries are assumed to have no credit risk. Credit risk is usually associated with corporate bonds.

Currency risk

The risk of incurring losses in the value of overseas investments as a result of movements in international exchange rates. Can also refer to the additional volatility caused by exposure to assets in foreign currencies.

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D

Default

Can be a) the failure to pay interest or principal promptly when due, or b) the failure 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. Bonds issued by the governments of most developed countries are generally regarded as having an extremely low default risk (AAA).

Defensive stock

A stock which is expected to be relatively insensitive to market or economic downturn, for example a food manufacturer.

Deflation

Negative inflation, i.e. falling prices.

Depression

A period of strongly negative economic growth and falling prices.

Derivative

A financial instrument such as a future or option whose payoffs (and ultimately value) are derived from the value of another (underlying) asset.

Devaluation

The formal reduction in the value of a currency against other currencies. This is opposed to depreciation, which is the reduction in the value of a currency through market movements.

Dilution

A reduction in earnings per share and book value per share due to an increase in the number of shares issued. This can occur if convertible securities are converted or warrants or employee stock options are exercised.

Discount rate

The rate of interest used to find the present value of a future cash flow.

Disinflation

A reduction in the rate of inflation.

Diversification

Holding a range of assets to reduce risk.

Dividend

The portion of company net profits paid out to equity investors.

Dividend discount model

A model used to estimate a security's value by adding all discounted future dividends of a company.

Dividend yield

The annual dividend on a share divided by the share price.

Downgrade

When a bond's credit rating is lowered. This might be caused by an event such as a negative trading statement by the issuer, which in turn increases the risk that the issuer might be unable to meet its future payment obligations. If the downgrade reduces an issue's credit rating to high yield status funds which only invest in investment grade bonds may need to sell the bond.

Due diligence

A detailed examination of information not all publicly available prior to a transaction e.g. an acquisition of one company by another.

Duration

The (Macaulay) duration is a measure of the average time until a bond's cash flows occur, and of the sensitivity of its price to interest rate changes. Technically speaking, the Macaulay duration is the sum of the time weighted discounted payments (coupons and principal) of a bond. Another way to think about duration is the average time period over which you will receive your payments. Hence, if two bonds have the same maturity, the bond with the higher coupon will have a shorter duration (the average time of repayment is less heavily weighted to the repayment of capital (principal) at maturity).

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E

Emerging markets

The investment markets of developing economies.

EONIA

Euro Overnight Index Average (EONIA) is the standard interest rate for Euro currency deposits. The European Central Bank is responsible for calculating the EONIA every day. It is often used in Europe as a benchmark for money market fund performance.

EURIBOR

The euro zone inter-bank offer rate for the euro. The rate at which banks offer to lend euros to other banks.

European Central Bank

The European Central Bank (ECB) is responsible for setting monetary policy (interest rates) within the euro zone. It was established in June 1998 as an essential part of the adoption of a single European currency.

Exchange traded fund (ETF)

A vehicle that is traded on a stock exchange and whose performance is designed to track a given market index. Exchange traded funds represent a low cost, highly liquid 'form' of index investing.

Expected return

The anticipated average future return. The actual return will generally differ.

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F

Financial Services Authority (FSA)

The body which regulates the financial industry in the UK.

Fiscal policy

The management of the economy by use of government spending and taxation.

Floating rate note (FRN)

A bond whose coupon varies with (short-term) interest rates. Floating rate bonds are generally issued by banks or companies whose earnings are closely tied to interest rate fluctuations as a way of more closely matching interest payments to earnings. Floating Rate Notes (FRNs) are bonds whereby the rate of interest ‘floats’ to reflect changes in interest rates or LIBOR.

Flotation

The first issue of shares to the public in a company new to the stock market. Also known as an Initial Public Offering (IPO).

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G

Government bond

A bond issued by a government.

Gross

Before deductions of, e.g. tax or investment fees.

Gross redemption yield

See yield.

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I

IMMFA

Institutional Money Market Funds Association (IMMFA) is the trade association for European providers of triple-A rated constant NAV money market funds (2a-7 style). The association provides a code of practice to all member funds.

Industry average benchmark

See peer group benchmark.

Inflation

A measure of the rate of increase in general prices, e.g. the movement over time in the Consumer Prices Index (CPI).

Institutional investor

An investor such as a pension fund, insurance company or charity.

Interest

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

Internal rate of return (IRR)

The average return on an investment over its life based on its current price and its future cash flows.

Investment consultant

An adviser on investment strategy and/or the selection of investment managers.

Investment style

A portfolio's exposure to (or an investment manager's preference for) large or small cap stocks, and to value or growth stocks.

ISIN

International Securities Identification Numbering system advocated by the G30. The ISIN code is a unique 12 digit code given to a security and is used worldwide.

ISMA

International Securities Markets Association.

Issuing house

This is the name given to financial institutions, often merchant banks, that act as intermediaries between companies seeking capital and the investors prepared to supply it.

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L

Large cap stock

A stock with a market capitalisation that is among the largest within a market e.g. the capitalisation of one of the top 100 companies in the UK as represented by the FTSE 100 index.

Liabilities

An investor's liabilities are the obligations that must be met, e.g. future pension payments for a pension fund, or claims on insurance policies for an insurer.

Liability-driven investing (LDI)

An investment philosophy which aims to help defined benefit pension schemes establish a risk framework from which they can measure investment risk and set investment strategy.

LIBID

London Interbank Bid Rate (LIBID) is an indicative rate that banks lend to other banks. Typically 7- day LIBID is used as a benchmark for triple-A rated money market funds. LIBID is not published by BBA, but is accepted as being LIBOR minus 0.125%.

LIBOR

London Interbank Offered Rate (LIBOR) is an indicative interest rate at which banks can borrow funds from other banks in the London interbank market. LIBOR is fixed on a daily basis by the British Bankers’ Association. LIBOR is the world’s most widely used benchmark for short-term interest rates.

LIFFE

The London International Financial Futures and Options Exchange Market for trading in derivatives.

Liquidity

The extent to which an asset can be bought and sold quickly and cheaply. Liquidity can be measured by the daily trading volume in a security.

Liquidity risk premium (LRP)

In order to overcome investors’ desire for liquidity, less liquid assets must offer a higher return ('premium') to compensate for reduced flexibility.

Listing

The FSA has taken responsibility for the listing of companies to the "official list". Inclusion in this list represents an endorsement from the FSA that the company has met minimum standards. It remains the responsibility of the London Stock Exchange (LSE) to admit a company's securities to trading on the exchange. Being "listed on the LSE" is therefore not the same as being "officially listed."

Longevity

The fact that people increasingly live longer. While a good thing, it unfortunately also means increased pension liabilities. The potential for further increases in life expectancy present a non-quantifiable risk for pension schemes as the pension is paid until death.

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M

Mandate

The agreement between a client and investment manager laying down how the fund is to be managed. May include performance targets by reference to a benchmark.

Mark-to-market

The regular adjustment of the recorded price of an asset so that it equals its market price.

Market capitalisation

The total value of a company or market. For a company, the number of shares multiplied by their market price. For a market, the sum of the market capitalisations of the constituents of that market.

Market inefficiency

A condition in which current security prices do not reflect all the publicly available information about a security, such as when some investors do not effectively analyse the available information.

Market neutral

An investment strategy (particularly associated with some hedge funds) that aims to produce returns that are independent of fluctuations in market returns.

Market price

The price at which an asset changes hands in an open market.

Market risk / Systematic risk

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

Market value

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

Maturity

1) For a bond, the time at which the principal of the bond is repayable and it ceases to exist. 2) For a pension fund, broadly the average age of the membership and the time until benefits are payable.

Minimum Funding Requirement (MFR)

A requirement introduced in the Pensions Act 1995 in an attempt to ensure that pension schemes have sufficient assets to meet their liabilities. It is now being replaced with scheme-specific funding requirements as set out by the Pension Protection Fund.

Modern portfolio theory

The blanket name for the quantitative analysis of assets based upon their expected return, expected risk (standard deviation) and their correlations. According to MPT, investors should only invest in portfolios (constituting of the previously analysed assets) which generate the highest return at any given level of risk.

Monetary policy

The management of the economy by the use of interest rates and money supply.

Money market

The market for short-term fixed income instruments (typically with less than one year to maturity).

Multi-asset management

A single manager is responsible for several asset classes and is measured against a peer group or customised benchmark which specifies a fixed asset allocation. (The manager may or may not have discretion to vary the allocation around this benchmark.)

Mutual fund

The US name for a pooled fund (usually open-ended) operated by an investment manager.

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N

Net Asset Value (NAV) is a term used to describe the per-share amount of the fund which is derived by dividing the total value of all the securities in a portfolio, less any liabilities, by the number of fund shares outstanding.

Net

After allowing for deductions of, e.g. tax or investment fees.

Net present value (NPV)

A method used in evaluating investments whereby all future cash flows are first discounted at a given discount rate and then added. An investment is acceptable if the NPV is positive.

Normal distribution

A bell-shaped curve often used to estimate the chances of different outcomes.

NRSRO

A Nationally Recognised Statistical Rating Organization (NRSRO) is a credit rating agency which issues credit ratings that the US Securities and Exchange Commission (SEC) permits other financial firms to use for certain regulatory purposes, e.g. Moody’s and Standard & Poor’s (S&P).

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O

Optimisation

The creation of a portfolio which will give you the highest expected total return for a given set of forecasts and estimated risks.

Outperformance

The return on a fund in excess of the benchmark return.

Overweight

Exposure to a given asset or asset class greater than that implied by its weight within a market index or benchmark against which the portfolio is measured. Investment managers may take overweight positions in shares or sectors they expect to outperform in order to add value to the portfolio.

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P

Peer group analysis

A ranking table of the competitive performance of investment managers / funds in, for example, a performance survey such as CAPS or WM.

Peer group benchmark

An investment benchmark implicitly defined to be the average asset allocation of an investment manager's competitors.

An investment management fee the extent of which is determined by the degree of over or under performance relative to an agreed benchmark.

Principal / Face value / Nominal amount

The amount inscribed on the face of a security, exclusive of interest or premium, due to a security holder at maturity and it is the amount used in the computation of interest due on such security.

Prospectus / Offering memorandum

A document, prepared by the lead manager to an issue containing all the pertinent information about a public offering of securities and about the borrower and guarantor, if any. It is made available to the appropriate legal authorities, stock exchanges and prospective investors. A preliminary prospectus is generally dispatched at the beginning of the subscription period and a final prospectus is dispatched immediately after both the final terms have been fixed and the subscription agreement has been signed by the borrower and the managers.

Proxy

A written authorisation given by a shareholder to someone else to vote on his behalf at a company's annual general meeting (AGM) or special meeting (EGM).

Public offering

An offering for sale of a new issue of securities to the general investing public. Securities of such an offering will generally be placed through a syndicate, will have securities issued in small denominations (e.g. £1,000 each), and will be listed on a stock exchange.

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R

Real assets

Assets which should have a natural link to the performance of the economy and the general level of prices (e.g. equities or real estate).

Real interest rate (or yield or return)

The interest rate (or yield or return) less the rate of inflation.

Repurchase agreement (REPO)

Repurchase Agreements (Repos) are instruments under which the funds sell portfolio securities and at the time of sale agrees to repurchase those securities at a mutually agreed time and price including interest payment. This is usually on an overnight basis.

Return

The income on an asset together with its capital appreciation, expressed as a proportion of the asset's initial price.

Reverse-Repo

For the party selling the security (and agreeing to repurchase it in the future) it is a repo; for the party on the other end of the transaction (buying the security and agreeing to sell it in the future), it is a reverse repurchase agreement.

Risk

In its simplest sense, 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. Risk management is an important aspect of portfolio management and may involve the use of complex statistical models.

Risk / Return trade off

The amount of expected return that must be sacrificed in order to reduce risk.

Risk premium

The extra expected return over the risk-free rate demanded by investors to compensate them for the volatility of returns or the possibility of default of risky assets.

Risk-free asset / Rate

An investment with no chance of default, and a known and certain rate of return. (Typically the yield on a government bond or cash.)

Rule 2a-7

SEC Rule 2a-7 is a regulation governing US onshore money market funds published by the US Securities and Exchange Commission (SEC). The regulation acted to define and standardise the asset class and set detailed parameters governing credit, market and operational risk.

Running yield (or current yield)

The current income from an asset divided by its price.

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S

Secondary market

The purchase and sale of securities which have previously been issued in the primary market.

Sector

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

Securities

Assets tradable in standardised units on secondary markets, particularly equities and bonds.

Securitisation

The creation of securities from non-tradable assets.

Short bond / Short dated bond

A bond with a term to redemption of less than five years.

SONIA

Sterling Overnight Interbank Average rate is an index that tracks Sterling overnight funding rates.

Sovereign debt

Bonds issued by a central government.

Specialist (mandate / portfolio)

A specialist investment mandate or portfolio is usually one involving a single asset class, region or investment style (as opposed to 'balanced').

Spread

The difference in yield between two different bonds. It is typically used to describe the extra yield offered by corporate bonds over gilts.

Stamp Duty and Reserve Tax (SDRT)

Stamp duty depends upon there being a document which can be stamped. For this reason SDRT was introduced in the UK in 1986 to cater for paperless transactions in shares. It is the tax paid on the transfer in beneficial ownership of certain types of asset, for example, units in UK unit trusts which invest in UK equities or property.

Stock market

A place for dealing in stocks and shares (equities) such as the London Stock Exchange.

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T

T-bill / Treasury bill

Treasury Bills are short-term debt obligations backed by the US Government with a maturity of less than one year - commonly 1-month, 3-months or 6-months. They are sold at a discount to par - where the difference between purchase price and redemption value represents the investor's return.

TER

Total Expense Ratio is a measure of the total costs associated with managing and operating an investment fund. These costs primarily consist of management fees and other administrative and operational expenses. The total cost of the fund is divided by the fund’s total assets to arrive at a
percentage amount which represents the TER.

Time Deposit

A deposit at a banking institution made for a certain (short) period of time.

Time-weighted rate of return

The rate of return on an asset or portfolio that adjusts for the effect of cash flows. The time weighted return can be used to compare portfolio performances against each other and against market indices.

Top-down

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

Total return

See return.

Treasuries

Central government bonds, often US government bonds.

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U

UCITS

UCITS stands for Undertakings for Collective Investments in Transferable Securities. UCITS is a European Union directive dating back to 1985, and amongst other things governs how a fund can be marketed cross-border within the European Union.

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W

WAM

Weighted Average Maturity (WAM) is the weighted average of the time until all securities within a fund mature. The WAM is used as a measure of interest rate risk.

Weighted average return

A rate of return that is weighted to take into account the relative sizes of the various assets or funds which make up the sample.

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Y

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 the percentage of the market price of the share. In the case of a property, it is the rental income as a percentage of the capital value. In the case of a bond 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 to maturity

The annualised return (internal rate of return) that would be earned on a bond if held to maturity.