Frequently used words in the ETF world
4 min

Frequently used words in the ETF world

Keen to invest in ETFs but can’t wrap your head around the terms and language? This guide will help you with the must-know words to impress your friends and be an ETF expert!

Speaking ETFs

Investing has its own language. And like learning any new language, understanding the definitions take time. Here are some key words and phrases to get you talking the talk.

Active investing

These are investments which are ‘actively managed’ by an investor to beat the performance of an index or benchmark. Managed funds are typically ‘active’ investments where you pay for the skill of the manager to beat the market.

Alpha

The amount by which an investment beats or outperforms an index or benchmark, typically applied to managed funds or other ‘active’ investments.

Asset Allocation

Asset allocation is one of the single most important ways of managing the risk and reward of your overall investment. By spreading your portfolio across different assets, say stocks, bonds, property and cash, you can achieve different levels of risk and potential return. How you asset allocate will depend on what you want – seeking high short-term gains will mean you will need to take more risk than if seeking steady returns over a long time>1.

Beta

This is the return of an investment relative to a market index. An investment with a beta of 1 moves up and down the same amount as the market. Most ETFs are ‘beta’ funds, designed to track the return of an index.

Diversification

Diversification1, while similar in concept to asset allocation, goes further in balancing risk and return. Asset allocation gives you some basic diversification by determining how much of your portfolio to invest in stocks, bonds, property etc. Deciding which specific stocks and bonds to invest in and by how much gives you further diversification.

The net result is if one of your investments isn’t tracking well, having a diversified portfolio potentially means the gains from your other investments may offset this. Diversification can be a way to seek to build an efficient investment portfolio that meets both your appetite for risk and return.

High-Yield Bonds

Many investors have some level of high-yield bonds in their portfolio as they offer attractive potential for income. A high-yield bond is debt often issued by a company with a low credit rating, the yield is high as investors can expect a potentially higher return to compensate for the greater risk.

Index

An index is a basket of securities representing a whole market or a submarket. It tracks the performance of this market and serves as a benchmark for investors or fund managers. Some common indexes include S&P500 index, the Straits Times index in Singapore or the Hang Seng index in Hong Kong.

Liquidity

Liquidity is simply how quickly an asset can be converted into cash. Basically, it is how the asset or security can be bought or sold without affecting the asset’s price. Knowing how ‘liquid’ the asset is will help you choose where to invest. The higher the liquidity, the easier and more cost effective it will be to trade. If it has low liquidity, this could indicate higher trading costs and potential difficultly in buying or selling.

Managed Fund

A managed fund is where your money is pooled with other investors and managed by a third-party investment manager who buys and sells stocks and assets on your behalf. Also known as mutual funds in other parts of the world, they are actively managed by the investment manager who is tasked to deliver returns that beat the index.

Minimum Volatility

Minimum volatility is an investment approach that aims to do as it says—minimize volatility. Simply put it is a strategy to seek to minimize the impact of market ups and downs. Tools under this strategy such as minimum volatility ETFs can help ensure minimal impact from changes in say interest rates, currency shifts, or rapid ups and downs in stock prices. Minimum volatility strategies aim to give you close to market return but with minimum risk2.

Physical ETF

A physical ETF tracks the target index by holding all or substantially all of the underlying assets of the index. For example, a Hang Seng ETF will give you access to either all of the stocks traded on the Hang Seng, or at least a core basket of those stocks. Physical ETFs are more commonly available, and are usually lower risk compared to, for example, synthetic ETFs.

Synthetic ETF

A synthetic ETF does not invest in assets directly. For example, instead of owning barrels of crude oil, a synthetic ETF tracking oil will hold a series of oil futures contracts. These agreements are set up with a third party, often an investment bank, who promises to pay back an agreed level of return when oil reaches a certain price. Because synthetic ETFs use derivative products they can come with greater risk. But you get access to assets normally out of reach, while also getting liquidity through the ability to trade at any time during the ETFs trading day.

Yield

The return from an investment. It is usually a percentage of the investment amount. For example, an ETF priced at $100 that paid a $5 dividend, has an historic yield of 5%.

Sources

  1. Asset allocation is a form of diversification. Diversification does not fully protect you from market risk and does not guarantee returns or eliminate potential for loss.
  2. While minimum volatility strategies tend to be designed with the aim of reducing risk, there are no guarantees they will attain a more conservative level of risk than the broader market.
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