Financial Terms Dictionary
An outright return achieved irrespective of overall market direction. Whereas traditional investments typically measure their success in terms of whether they track or outperform a key market benchmark or index (relative returns), hedge funds and alternative investment strategies aim to achieve outright positive returns irrespective of whether asset prices or key market indices rise or fall (i.e. absolute returns rather than relative returns).
An algorithm is a set of instructions for solving a problem or accomplishing a task. One common example of an algorithm is a recipe, which consists of specific instructions for preparing a dish or meal. Every computerized device uses algorithms to perform its functions in the form of hardware- or software-based routines.
In finance, algorithms have become important in developing automated and high-frequency trading (HFT) systems, as well as in the pricing of sophisticated financial instruments like derivatives.
Widely considered to be a measure of the ‘value added’ by an investment manager. It is therefore regarded as a proxy for manager or strategy skill. Alpha is sometimes described as out performance of a benchmark or the return generated by an investment independent of the market – what an investment would hypothetically achieve if the market return was zero. More specifically, alpha is sometimes described as the return of an investment less the risk-free interest rate, or the return of the portfolio less the return on the S&P 500 index or some other relevant benchmark index.
Altcoins are cryptocurrencies other than Bitcoin. They share characteristics with Bitcoin but are also different from them in other ways. For example, some altcoins use a different consensus mechanism to produce blocks or validate transactions. Or, they distinguish themselves from Bitcoin by providing new or additional capabilities, such as smart contracts or low-price volatility.
As of March 2021, there were almost 9,000 cryptocurrencies. According to CoinMarketCap, altcoins accounted for over 40% of the total cryptocurrency market in March 2021.1Because they are derived from Bitcoin, altcoin price movements tend to mimic Bitcoin’s trajectory. However, analysts say the maturity of cryptocurrency investing ecosystems and the development of new markets for these coins will make price movements for altcoins independent of Bitcoin’s trading signals.
The terms ‘alternative investment’ and ‘hedge fund’ are often used interchangeably as hedge funds are an important and growing part of the alternative investment arena, which also includes private equity and debt, venture capital and real estate. In the field of asset management, the essential defining feature of alternative investments is the pursuit of absolute returns. That is:
- the quest to achieve a positive return regardless of whether asset prices are rising or falling
- freedom to trade in a wide range of assets and instruments employing a variety of styles and investment techniques in diverse markets
- reliance on the investment manager’s skill and application of a clear investment process to exploit market inefficiencies and opportunities with identifiable and understandable causes and origins
Alternative investment managers may take advantage of pricing anomalies between related securities, engage in ‘momentum’ investing to capture market trends or utilize their expert knowledge of markets and industries to capture profit opportunities that arise from special situations.
The ability to use derivatives, arbitrage techniques and, importantly, short selling – selling assets that one does not own in the expectation of buying them back at a lower price – affords alternative investment managers rich possibilities to generate growth in falling, rising and unstable markets.
The technique of exploiting pricing anomalies between related securities within and between markets with the aim of producing positive returns independent of the direction of broad market prices. By establishing long positions in under-valued assets and short positions in over-valued assets, arbitrageurs aim to capture profit opportunities that arise from the changing price relationship between the assets concerned. Specific investment styles that apply arbitrage techniques include convertible bond arbitrage, fixed income arbitrage, statistical arbitrage and merger or risk arbitrage.
Basic earnings per share (EPS) tells investors how much of a firm’s net
income was allotted to each share of common stock. It is reported in a
company’s income statement and is especially informative for businesses
with only common stock in their capital structures.
Although the term “basis” holds various meanings in finance, it most frequently refers to the difference between the prices and the expenses involved in transactions when calculating taxes. Such usage relates to the broader terms “cost basis” or “tax basis” and is specifically used when capital gains or losses are calculated for income tax filings.
Basis points (BPS) refers to a common unit of measure for interest rates and other percentages in finance. One basis point is equal to 1/100th of 1%, or 0.01%, or 0.0001, and is used to denote the percentage change in a financial instrument. The relationship between percentage changes and basis points can be summarized as follows: 1% change = 100 basis points and 0.01% = 1 basis point.
Basis points are typically expressed in the abbreviations “bp,” “bps,” or “bips.”
A measure of how sensitive an investment portfolio is to market movements. The sign of the beta (+/-) indicates whether, on average, the portfolio’s returns move in line with the market (+), or in the opposite direction (-) to the market. If the beta of a portfolio relative to a benchmark index is equal to +1, then the returns on the portfolio follow those of the index. By definition, the beta of that benchmark index is +1. A portfolio with a beta greater than +1 tends to amplify the overall movements of the market, while a portfolio with a beta between 0 and +1 tends to move in the same direction as the market but not to the same extent. A portfolio with a beta of -1 tends to move in the opposite direction to the market.
Bitcoin is a decentralized digital currency created in January 2009. It follows the ideas set out in a whitepaper by the mysterious and pseudonymous Satoshi Nakamoto.1 The identity of the person or persons who created the technology is still a mystery. Bitcoin offers the promise of lower transaction fees than traditional online payment mechanisms and, unlike government-issued currencies, it is operated by a decentralized authority.
Bitcoin is known as a type of cryptocurrency because it uses cryptography to keep it secure. There are no physical bitcoins, only balances kept on a public ledger that everyone has transparent access to (although each record is encrypted). All bitcoin transactions are verified by a massive amount of computing power via a process known as “mining.” Bitcoin is not issued or backed by any banks or governments, nor is an individual bitcoin valuable as a commodity. Despite it not being legal tender in most parts of the world, bitcoin is very popular and has triggered the launch of hundreds of other cryptocurrencies, collectively referred to as altcoins. Bitcoin is commonly abbreviated as “BTC” when traded.
If you have been following banking, investing, or cryptocurrency over the last ten years, you may have heard the term “blockchain,” the record-keeping technology behind the Bitcoin network.
Blockchain seems complicated, and it definitely can be, but its core concept is really quite simple. A blockchain is a type of database. To be able to understand blockchain, it helps to first understand what a database actually is.
A database is a collection of information that is stored electronically on a computer system. Information, or data, in databases is typically structured in table format to allow for easier searching and filtering for specific information. What is the difference between someone using a spreadsheet to store information rather than a database?
Spreadsheets are designed for one person, or a small group of people, to store and access limited amounts of information. In contrast, a database is designed to house significantly larger amounts of information that can be accessed, filtered, and manipulated quickly and easily by any number of users at once.
An investment strategy whereby an investor considers companies based on their own merit rather than the sectors they are part of or the current economic climate. Opposite of Top-down.
The amount of investment capital that can be comfortably absorbed by a manager or strategy without a diminishing of returns. One useful indication of whether or not a manager or strategy faces capacity constraints is to analyze the degree to which they experience slippage [see Slippage] in the execution of their strategy or trades.
The capital adequacy ratio (CAR) is a measurement of a bank’s available capital expressed as a percentage of a bank’s risk-weighted credit exposures. The capital adequacy ratio, also known as capital-to-risk weighted assets ratio (CRAR), is used to protect depositors and promote the stability and efficiency of financial systems around the world. Two types of capital are measured: tier-1 capital, which can absorb losses without a bank being required to cease trading, and tier-2 capital, which can absorb losses in the event of a winding-up and so provides a lesser degree of protection to depositors.
See Principal Protection
A fund which employs stringent risk controls which have to comply to fixed risk parameters.
Commission sharing is the process whereby Man Group companies recapture some of the commission paid to brokers as part of their normal course trading activities. Recaptured commissions are used to purchase substantive research, and services directly related to the execution of trades (“research and execution services”). Recaptured commission will only ever be used to pay for research and execution services where there is reasonable benefit to clients. Commission sharing is permitted by the UK Financial Conduct Authority, our lead regulator. Please contact us should you require more information on Commission Sharing.
A raw material or primary agricultural product that can be bought and sold, for example oil or wheat.
The manager or adviser of a managed futures [see Managed futures] fund. The term reflects the fact that early futures markets [see Futures] were commodities-based and were set up to enable producers and buyers to hedge against possible price movements in the underlying asset.
The compounded ‘growth’ of an investment that has been achieved each year to enable the initial price to grow to the latest selected price over a particular time period.
A strategy that synthetically reproduces the pay-out of a put or call option through dynamically adjusting the delta hedge of the underlying asset. Unlike a conventional option, the investment exposure (or participation) of the underlying asset will change over the life of the structure.
An index or similar factor that fund managers use to limit or constrain how they construct a fund’s portfolio.
A bond issued by a company that has a set maturity date and pays interest in the form of a coupon. It has features of both a bond and stock and its valuation reflects both types of investments. It gives the holder the option to convert the bond into a specific number of shares of the issuing company – in other words, it has an ’embedded option’.
A measure of the interdependence or strength of the relationship between two investments. A correlation of 1 means that the two investments are perfectly synchronised, while a correlation of -1 implies that they move in symmetrically opposite directions.
Cost of capital is the required return necessary to make a capital budgeting project, such as building a new factory, worthwhile. When analysts and investors discuss the cost of capital, they typically mean the weighted average of a firm’s cost of debt and cost of equity blended together.
The cost of capital metric is used by companies internally to judge whether a capital project is worth the expenditure of resources, and by investors who use it to determine whether an investment is worth the risk compared to the return. The cost of capital depends on the mode of financing used. It refers to the cost of equity if the business is financed solely through equity, or to the cost of debt if it is financed solely through debt.
Many companies use a combination of debt and equity to finance their businesses and, for such companies, the overall cost of capital is derived from the weighted average cost of all capital sources, widely known as the weighted average cost of capital (WACC).
An agreement permitting a buyer to receive something of value now, with an obligation to repay this at some date in the future, generally with interest.
Regulation Crowdfunding enables eligible companies to offer and sell securities through crowdfunding.
- require all transactions under Regulation Crowdfunding to take place online through an SEC-registered intermediary, either a broker-dealer or a funding portal
- permit a company to raise a maximum aggregate amount of $5 million through crowdfunding offerings in a 12-month period
- limit the amount individual non-accredited investors can invest across all crowdfunding offerings in a 12-month period and
- require disclosure of information in filings with the Commission and to investors and the intermediary facilitating the offering
Securities purchased in a crowdfunding transaction generally cannot be resold for one year.
Crowdfunding is the use of small amounts of capital from a large number of individuals to finance a new business venture. Crowdfunding makes use of the easy accessibility of vast networks of people through social media and crowdfunding websites to bring investors and entrepreneurs together, with the potential to increase entrepreneurship by expanding the pool of investors beyond the traditional circle of owners, relatives, and venture capitalists.
The specific day on which investors can subscribe (buy) or redeem (sell) their holding in a product, as detailed in the relevant product legal document. The dealing day can be daily, weekly, monthly or quarterly, depending on product valuation frequency.
Decentralized finance, or DeFi, is a system by which financial products become available on a public decentralized blockchain network. That makes them open to anyone to use, rather than going through middlemen like banks or brokerages. Unlike a bank or brokerage account, a government-issued ID, Social Security number, or proof of address are not necessary to use DeFi. More specifically, DeFi refers to a system by which software written on blockchains makes it possible for buyers, sellers, lenders, and borrowers to interact peer to peer or with a strictly software-based middleman rather than a company or institution facilitating a transaction.
Multiple technologies and protocols are used to achieve the goal of decentralization. For example, a decentralized system can consist of a mix of open-source technologies, blockchain, and proprietary software. Smart contracts that automate agreement terms between buyers and sellers or lenders and borrowers make these financial products possible. Regardless of the technology or platform used, DeFi systems are designed to remove intermediaries between transacting parties.
Though the volume of trading tokens and money locked in smart contracts in its ecosystem has been growing steadily, DeFi is an incipient industry whose infrastructure is still being built out. Regulation and oversight of DeFi are minimal or absent.
The sensitivity of an option price to moves in the price of the underlying asset.
Financial contracts such as futures [see Futures], options and various securities that offer ‘synthetic’ access to an underlying asset such as a commodity, stock market or fixed income security. The price movements of a derivative generally follow the price movements of the underlying asset but derivatives generally require only small amounts of capital (margin) to gain exposure to the underlying asset.
By employing long/ short investing and hedging strategies the investment may be able to provide protection against severe market drawdowns.
An investment is said to be in a drawdown when its price falls below its last peak [see Net new highs]. The drawdown is the percentage drop in the price of an investment from its last peak price. The period between the peak level and the trough is called the length of the drawdown, and the period between the trough and the recapturing of the peak is called the recovery. The worst or maximum drawdown represents the greatest peak to trough decline over the life of an investment.
An ownership right representing an interest in a company.
Profits from taking up long and offsetting short positions in undervalued and overvalued stocks with a fixed or variable underlying net long or short exposure.
Earnings before interest, taxes, and amortization (EBITA) is a measure of company profitability used by investors. It is helpful for comparison of one company to another in the same line of business. In some cases, it also can provide a more accurate view of the company’s real performance over time.
Another similar measure adds depreciation to the list of factors to be eliminated from the earnings total. That is earnings before interest, taxes, depreciation, and amortization (EBITDA).
A company’s EBITA is considered by some analysts and investors to be a more accurate representation of its real earnings. It removes from the equation the taxes owed, the interest on company debt, and the effects of amortization, which is the accounting practice of writing off the cost of an intangible asset over a period of years.
EBITA vs. EBITDA
EBITA is not used as commonly as EBITDA, which adds depreciation into the calculation. Depreciation, in company accounting, is the recording of the reduced value of the company’s tangible assets over time. It’s a way of accounting for the wear and tear on assets such as equipment and facilities. Some companies, such as those in the utilities, manufacturing, and telecommunications industries, require significant expenditures in equipment and infrastructure, which are reflected in their books.
An equity fund is a mutual fund that invests principally in stocks. It can be actively or passively (index fund) managed. Equity funds are also known as stock funds.
Stock mutual funds are principally categorized according to company size, the investment style of the holdings in the portfolio and geography.
Financial health is a term used to describe the state of one’s personal monetary affairs. There are many dimensions to financial health, including the amount of savings you have, how much you’re putting away for retirement, and how much of your income you are spending on fixed or non-discretionary expenses.
Financial Ratios are powerful tools to help summarize financial statements and the health of a company or enterprise.
Financial technology (Fintech) is used to describe new tech that seeks to improve and automate the delivery and use of financial services. At its core, fintech is utilized to help companies, business owners and consumers better manage their financial operations, processes, and lives by utilizing specialized software and algorithms that are used on computers and, increasingly, smartphones. Fintech, the word, is a combination of “financial technology”.
When fintech emerged in the 21st Century, the term was initially applied to the technology employed at the back-end systems of established financial institutions. Since then, however, there has been a shift to more consumer-oriented services and therefore a more consumer-oriented definition. Fintech now includes different sectors and industries such as education, retail banking, fundraising and nonprofit, and investment management to name a few.
Fintech also includes the development and use of crypto-currencies such as bitcoin. While that segment of fintech may see the most headlines, the big money still lies in the traditional global banking industry and its multi-trillion-dollar market capitalization.
A security that pays a specific level of interest. An example of a fixed income security is a bond issued by a government or large company.
A forward contract is a customised contract between two counterparties to buy or sell a specific asset on a future date at an agreed price. As opposed to stocks and bonds, a forward contract is a derivative instrument, the value of which depends on an underlying asset. Unlike standard futures contracts, forward contracts are not traded on a centralised exchange and are highly customisable.
The underlying proposition of fundamental analysis is that there is a basic intrinsic value for the aggregate stock market, various industries or individual securities and that these depend on underlying economic factors. The identification and analysis of relevant variables combined with the ability to quantify the future value of these variables are key to achieving superior investment results. A wide range of financial information is evaluated in fundamental analysis, including such income statement data as sales, operating costs, pre-tax profit margin, net profit margin, return on equity, cash flow, and earnings per share.
Fundamental analysis contrasts with technical analysis which contends that the prices for individual securities and the overall value of the market tend to move in trends that persist.
A future is a derivative instrument [see Derivatives] that involves a contract to buy or sell an asset (stock index, commodity, currency, fixed income or other security) for delivery at a future date at a specific price.
Gearing refers to the relationship, or ratio, of a company’s debt-to-equity (D/E). Gearing shows the extent to which a firm’s operations are funded by lenders versus shareholders—in other words, it measures a company’s financial leverage. When the proportion of debt-to-equity is great, then a business may be thought of as being highly geared, or highly leveraged.
Gearing ratios are financial ratios that compare some form of owner’s equity (or capital) to debt, or funds borrowed by the company. Gearing is a measurement of the entity’s financial leverage, which demonstrates the degree to which a firm’s activities are funded by shareholders’ funds versus creditors’ funds.
The gearing ratio is a measure of financial leverage that demonstrates the degree to which a firm’s operations are funded by equity capital versus debt financing.
The general business tax credit is the total value of all the individual credits to be applied against income on a tax return. This credit can be carried forward for a number of years in most cases and can also be carried back in some cases.
A global registered share (GRS), or a global share, is a security that is issued in the United States, but it is registered in multiple markets around the world and trades in multiple currencies. With global shares, identical shares may trade on different stock exchanges and in various currencies across country borders without needing to be converted into local currencies. All holders of global shares, as with any other shareholder, have equal rights—such as voting, percentage of dividends, and so forth—in the issuing corporation.
A hurdle rate is the minimum rate of return on a project or investment required by a manager or investor. It allows companies to make important decisions on whether or not to pursue a specific project. The hurdle rate describes the appropriate compensation for the level of risk present—riskier projects generally have higher hurdle rates than those with less risk.
In order to determine the rate, the following are some of the areas that must be taken into consideration: associated risks, cost of capital, and the returns of other possible investments or projects.
High-frequency trading, also known as HFT, is a method of trading that uses powerful computer programs to transact a large number of orders in fractions of a second. It uses complex algorithms to analyze multiple markets and execute orders based on market conditions. Typically, the traders with the fastest execution speeds are more profitable than traders with slower execution speeds.
In addition to the high speed of orders, HFT is also characterized by high turnover rates and order-to-trade ratios. Some of the best-known HFT firms include Tower Research, Citadel LLC, and Virtu Financial.
A hybrid fund is an investment fund that is characterized by diversification among two or more asset classes. These funds typically invest in a mix of stocks and bonds. They may also be known as asset allocation funds.
Understanding Hybrid Funds
Hybrid funds offer investors a diversified portfolio. The term hybrid indicates that the fund strategy includes investment in multiple asset classes. In general, it can also mean that the fund uses an alternative mixed management approach.
Hybrid funds are commonly known as asset allocation funds. In the investment market, asset allocation funds can be used for many purposes. These funds offer investors an option for investing in multiple asset classes through a single fund.
Hybrid funds evolved from the implementation of modern portfolio theory in fund management. These funds can offer varying levels of risk tolerance ranging from conservative to moderate and aggressive.
- Balanced funds are also a type of hybrid fund. Balanced funds often follow a standard asset allocation proportion, such as 60/40.
- Target date funds or lifecycle funds also fit into the hybrid category. These funds invest in multiple asset classes for diversification. Target date funds vary from standard hybrid funds in that their portfolio portions begin with a more aggressive allocation and progressively rebalance to a more conservative allocation for use by a specified utilization date.
- A blend fund (or blended fund) is a type of equity mutual fund that includes a mix of both value and growth stocks. These funds offer investors diversification among these popular investment styles in a single portfolio.
A hybrid security is a single financial security that combines two or more different financial instruments. Hybrid securities, often referred to as “hybrids,” generally combine both debt and equity characteristics. The most common type of hybrid security is a convertible bond that has features of an ordinary bond but is heavily influenced by the price movements of the stock into which it is convertible.
Hedge fund products which pay an income stream are a type of structured product which continues to grow in popularity. The benefit of this type of structure is that it provides a transparent payoff profile through regular (for example semi-annual) defined income payments for a fixed term.
An intangible asset is an asset that is not physical in nature. Goodwill, brand recognition and intellectual property, such as patents, trademarks, and copyrights, are all intangible assets. Intangible assets exist in opposition to tangible assets, which include land, vehicles, equipment, and inventory.
Additionally, financial assets such as stocks and bonds, which derive their value from contractual claims, are considered tangible assets.
An investment region is the primary geographic region a fund is focused on. For example, an emerging markets fund will invest exclusively in emerging economies, such as Brazil, India, Mexico and Russia.
Typical investment regions include
- Emerging Markets
- United Kingdom
- United States
The term investment strategy refers to a set of principles designed to help an individual investor achieve their financial and investment goals. This plan is what guides an investor’s decisions based on goals, risk tolerance, and future needs for capital.1 They can vary from conservative (where they follow a low-risk strategy where the focus is on wealth protection) while others are highly aggressive (seeking rapid growth by focusing on capital appreciation).2
Investors can use their strategies to formulate their own portfolios or do so through a financial professional. Strategies aren’t static, which means they need to be reviewed periodically as circumstances change.3
One refers to an `initial public offering (IPO)` when a private company sells shares of its stock to the general public for the first time via a securities exchange. Through this process, a private company transforms into a public company.
Basic earnings per share (EPS) tells investors how much of a firm’s net
income was allotted to each share of common stock. It is reported in a
company’s income statement and is especially informative for businesses
with only common stock in their capital structures.
Kaizen is a Japanese term meaning “change for the better” or “continuous improvement.” It is a Japanese business philosophy regarding the processes that continuously improve operations and involve all employees. Kaizen sees improvement in productivity as a gradual and methodical process.
The concept of kaizen encompasses a wide range of ideas. It involves making the work environment more efficient and effective by creating a team atmosphere, improving everyday procedures, ensuring employee engagement, and making a job more fulfilling, less tiring, and safer.
Key performance indicators (KPIs) refer to a set of quantifiable measurements used to gauge a company’s overall long-term performance.
KPIs specifically help determine a company’s strategic, financial, and operational achievements, especially compared to those of other businesses within the same sector.
Keiretsu is a Japanese term referring to a business network made up of different companies, including manufacturers, supply chain partners, distributors, and occasionally financiers. They work together, have close relationships, and sometimes take small equity stakes in each other, all the while remaining operationally independent. Translated literally, keiretsu means “headless combine.”
The knowledge economy is a system of consumption and production that is based on intellectual capital. In particular, it refers to the ability to capitalize on scientific discoveries and basic and applied research. This has come to represent a large component of all economic activity in most developed countries. In a knowledge economy, a significant component of value may thus consist of intangible assets such as the value of its workers’ knowledge or intellectual property.
Key ratio is the name given to any financial ratio that’s considered particularly effective at measuring, illustrating, and summarizing a company’s financials in relation to its competitors or peers.
Investors and companies rely on key ratios all the time to get a snapshot of liquidity, efficiency, profitability, and so forth. Each key ratio focuses on a particular aspect of the company, meaning it is often necessary to consult several of them to get a more complete idea of how the subject is faring. Those that are in sound financial health will have superior ratios to those that are performing poorly.
Leverage and gearing effectively mean the same thing: the process or effect of ‘gearing up’ or magnifying exposure to an investment strategy, manager or asset. Leverage can be achieved by borrowing capital or using derivatives. A leveraged investment is subject to a multiplied effect regarding the profit or loss that results from a comparatively small change in price. Thus leverage offers the opportunity to achieve enhanced returns, but at the same time typically involves greater risk and can result in a loss that is proportionally greater than the amount invested.
A relative term to describe the speed at which an asset or assets can be converted into cash (liquidated) and vice versa. Common terms include
- Other – such as quarterly or ad hoc.
An interval during which an investment may not be sold.
Buying securities that are considered undervalued in the expectation that they will rise in value.
Profits from taking long and offsetting short positions in undervalued and overvalued securities with a fixed or variable underlying net long or short exposure.
A factor that is relevant to a broad economy at a regional or national level. For example, such factors include economic output, unemployment, inflation, savings and investment.
The segment of the alternative investment industry which actively trades and manages futures instruments [see Futures]. The advisers that focus their asset management efforts on futures are known as CTAs [see Commodity Trading Adviser]. They invest on both the long and short side of the market and usually employ quantitative or technical analysis [see Quantitative analysis] and systematic investment processes.
The amount of capital that has to be deposited as collateral in order to gain full exposure to an asset.
Denotes an approach to investment where the emphasis is on the value of securities relative to each other and the use of arbitrage techniques [see Arbitrage], rather than market direction forecasting. By emphasising the relative value of securities and the exploitation of pricing anomalies between related securities, practitioners of market neutral approaches aim to generate profits regardless of the overall direction of broad market prices. Market neutrality is generally achieved by offsetting, or hedging, long and short positions or maintaining balanced exposure in the market. The term market neutral can be applied with some justification to the majority of alternative investment styles because of their ability to capitalise on both upward and downward price moves or to profit in a wide range of market environments.
A mathematical technique used to model the price characteristics of an investment structure based on random simulations of the underlying assets or variables that affect the price of that investment. In the context of the modeling carried out at Man, the analysis involves constructing multiple NAV paths for a product, net of all appropriate fees and interest, using random samples of gross monthly returns. The price characteristics that can be modeled using this powerful technique are known as ‘path-dependent’ characteristics, such as risk, return, and drawdowns, which depend on NAV movements over the life of an investment structure.
The speed of price change over a period of time. Momentum-based investment styles, notably trend following approaches, aim to capitalise on the acceleration in directional price movements, be they upward or downward.
A widely used composite index of capital-weighted stocks developed by Morgan Stanley Capital International, which can act as a proxy for world stocks when assessing the relative performance of any portfolio with global asset exposure.
An investment that combines a number of asset classes, for example stocks and bonds.
A net new high is reached when the net asset value of an investment exceeds the previous peak level in the net asset value (also known as the ‘high watermark’). Performance fees [see Performance fee] are levied on net new highs.
An investment product with no defined lifespan. New units (e.g. shares, bonds, units, notes) are created or dissolved as required. Investors can subscribe (buy) or redeem (sell) these units at the prevailing net asset value per unit in accordance with the details set out in the relevant product prospectus.
A derivative instrument [see Derivatives] that gives the holder the right, without obligation, to buy (call) or sell (put) a security or asset at a fixed price within a specified period or at a particular future date.
By plotting the intersection of risk and reward for different investments or weightings of assets, one can generate a risk/reward curve or ‘frontier’ for those investments. The efficient frontier is the point on such a curve where an investment combination delivers the most favorable balance of risk and reward.
An arrangement or mechanism built into an investment product whereby investors are assured that their initial investment is secure and that this amount will at the very least be returned to them when such a product reaches its maturity date. Principal protection features can take a variety of forms, including capital guarantees provided by banks.
In the context of a long/short equity approach, a prime broker acts as the intermediary between the two counterparties involved in short selling by matching a stock borrower (equity long/short manager) with a stock lender (typically a pension fund or large institution). The prime broker also collects margin payments from short sellers should the market price of the stock move against them.
A representation of a track record [see Track record] that is developed to show the effect on actual performance of intended or potential adjustments for different fee structures, portfolio allocations or other variations in the investment structure upon which the original track record is based. It is important to note that a pro forma is based on actual trading results and differs from a simulation, which models the hypothetical performance of a portfolio or investment approach that has yet to be applied or implemented in actual trading.
Analysis that uses subjective judgment to evaluate securities based on non-financial information such as management expertise, cyclicality of industry, strength of research and development, labor relations and depth of operational infrastructure.
Qualitative analysis evaluates important factors that cannot be precisely measured rather than the actual financial data about a company.
Quantitative analysis uses statistical techniques to develop investment models using key financial ratios and economic indicators. The use of objective data facilitates the comparison of a large universe of securities to identify a select range of potential investment possibilities.
Quantitative analysis deals with measurable factors in contrast to qualitative considerations such as the character of management.
Risk tolerance is the degree of variability in investment returns that an investor is willing to withstand in their financial planning. Risk tolerance is an important component in investing. You should have a realistic understanding of your ability and willingness to stomach large swings in the value of your investments; if you take on too much risk, you might panic and sell at the wrong time.
Risk tolerance is often associated with age, although that is not the only determining factor. However, in a general sense, people who are younger and have a longer time horizon are often able to and are encouraged to take on greater risk than people older with a shorter-term horizon.
Greater risk tolerance is often synonymous with equities and equity funds and ETFs, while lower risk tolerance is often associated with bonds, bond funds, and ETFs. But age itself shouldn’t determine a switch in asset classes. Those with a higher net worth and more disposable income can also typically afford to take greater risks with their investments.
Before an individual embarks upon an investment or a company on a specific project, they seek to determine the benefit, or profit, that they will achieve from doing so.
There are many methods of discovering the return of an investment, and usually, an investor or company will seek a required rate of return before they move ahead with the investment or project.
The required rate of return (RRR) is the minimum amount of profit (return) an investor will seek or receive for assuming the risk of investing in a stock or another type of security.
RRR is also used to calculate how profitable a project might be relative to the cost of funding that project. RRR signals the level of risk that’s involved in committing to a given investment or project. The greater the return, the greater the level of risk.
Risk relative to return – the return achieved per unit of risk or the risk associated with a particular level of reward, typically represented by the Sharpe ratio [see Sharpe ratio]. Improving the risk-adjusted return depends either on increasing returns and maintaining the level of risk or maintaining the level of returns and lowering the associated risk.
A measure of risk-adjusted performance [see Risk-adjusted performance] that indicates the level of excess return per unit of risk. In the calculation of Sharpe ratio, excess return is the return over and above the short-term risk free rate of return and this figure is divided by the risk, which is represented by the annualized volatility or standard deviation [see Volatility and Standard deviation]. The greater the Sharpe ratio the greater the risk-adjusted return.
A trading technique whereby an investment manager arranges to borrow stock from a stock lender with a view to selling it and buying it back at a lower price in the future.
The difference between the sample or target price for buying or selling an asset and the actual price at which the transaction takes place.
A smart contract is a self-executing contract with the terms of the agreement between buyer and seller being directly written into lines of code. The code and the agreements contained therein exist across a distributed, decentralized blockchain network. The code controls the execution, and transactions are trackable and irreversible.
Smart contracts permit trusted transactions and agreements to be carried out among disparate, anonymous parties without the need for a central authority, legal system, or external enforcement mechanism.
While blockchain technology has come to be thought of primarily as the foundation for bitcoin, it has evolved far beyond underpinning the virtual currency.
A measure of risk-adjusted performance [see Risk-adjusted performance] that indicates the level of excess return per unit of downside risk. It differs from the Sharpe ratio [see Sharpe ratio] in that it recognizes investors’ preference for upside (‘good’) over downside (‘bad’) volatility and uses a measure of ‘bad’ volatility as provided by semi-deviation – the annualized standard deviation of the returns that fall below a target return, say the risk free rate.
A widely used measurement of risk, usually used to represent volatility [see Volatility], derived by calculating the square root of the variance of the returns of an investment from their mean.
An investment strategy whereby an investor considers companies based on their own merit rather than the sectors they are part of or the current economic climate. Opposite of Top-down.
Typically provides principal protection [see Principal protection], invests across a range of styles and managers, provides increased investment exposure [see Leverage] and requires a high level of structuring expertise with respect to blending investment approaches, financing, liquidity and risk management.
An individual hedge fund’s strategy/investment approach can generally be categorized into one of five main styles: equity hedge, event driven, global macro, managed futures or relative value. Practitioners of a particular style will have their own investment process or strategy with unique distinguishing features and techniques.
An index or similar factor that is part of a target a fund manager has set for a fund’s performance to match or exceed (including anything used for performance fee calculation).
The basic premise of technical analysis is that prices move in trends that persist and this characteristic can be used to achieve superior returns. Technical analysis often uses computer programmes to examine market data such as prices and volume of trading to make an estimate of future price trends and an investment decision.
Unlike fundamental analysis, technical analysis is not concerned with the financial position of a company.
The total percentage return of an investment over a specified period, calculated by expressing the difference between the investment’s initial price and final price as a percentage of the initial price.
A performance report produced by an investment manager that is made available, usually on a monthly basis, to clients with holdings in a particular product. The report details the change in net asset value of a product and explains performance in light of market conditions as well as any relevant portfolio changes and developments.
The actual performance of an investment since inception, usually represented by audited monthly returns, net of fees.
The general direction of the market, such as a relatively persistent upward or downward price movement over a period, sometimes represented by the mean of price changes in that period.
An investment strategy whereby an investor finds the best sectors to invest in and then searches for the best companies within those sectors or industries. Opposite of Bottom-up.
A generic term used to describe the ‘instrument’ (share, bond, unit, note) which is issued by a product. Investors subscribe to or invest in a product by buying units and redeem their holding by selling units at the prevailing net asset value per unit, as detailed in the relevant legal document.
Value is the monetary, material, or assessed worth of an asset, good, or service. “Value” is attached to a myriad of concepts including shareholder value, the value of a firm, fair value, and market value. Some of the terms are well-known business jargon, and some are formal terms for accounting and auditing standards of reporting to the Securities and Exchange Commission (SEC).
Value at risk (VaR) is a statistic that quantifies the extent of possible financial losses within a firm, portfolio, or position over a specific time frame. This metric is most commonly used by investment and commercial banks to determine the extent and probabilities of potential losses in their institutional portfolios.
Risk managers use VaR to measure and control the level of risk exposure. One can apply VaR calculations to specific positions or whole portfolios or use them to measure firm-wide risk exposure.
Variability, almost by definition, is the extent to which data points in a statistical distribution or data set diverge—vary—from the average value, as well as the extent to which these data points differ from each other. In financial terms, this is most often applied to the variability of investment returns. Understanding the variability of investment returns is just as important to professional investors as understanding the value of the returns themselves. Investors equate a high variability of returns to a higher degree of risk when investing.
Volatility is a statistical measure of the dispersion of returns for a given security or market index. In most cases, the higher the volatility, the riskier the security. Volatility is often measured as either the standard deviation or variance between returns from that same security or market index.
In the securities markets, volatility is often associated with big swings in either direction. For example, when the stock market rises and falls more than one percent over a sustained period of time, it is called a “volatile” market. An asset’s volatility is a key factor when pricing options contracts.
The Wall Street Journal Prime Rate is an aggregate average of the various prime rates that 10 of the largest banks in the United States charge to their highest credit quality customers for loans with relatively short-term maturities.1
This combined rate is obtained by way of a market survey and published regularly by The Wall Street Journal (WSJ).
The weighted average cost of capital (WACC) is a calculation of a firm’s cost of capital in which each category of capital is proportionately weighted. All sources of capital, including common stock, preferred stock, bonds, and any other long-term debt, are included in a WACC calculation.
A firm’s WACC increases as the beta and rate of return on equity increase because an increase in WACC denotes a decrease in valuation and an increase in risk.
X-efficiency refers to the degree of efficiency maintained by firms under conditions of imperfect competition. Efficiency in this context means a company getting the maximum outputs from its inputs, including employee productivity and manufacturing efficiency. In a highly competitive market, firms are forced to be as efficient as possible to ensure strong profits and continued existence. This is not true in situations of imperfect competition, such as with a monopoly or duopoly.
An X-mark signature is made by a person in lieu of an actual signature. Due to illiteracy or disability, a person may be unable to append a full signature in name to a document as an attestation that its content has been reviewed and approved. In order to be legally valid, the X-mark signature must be witnessed.
Year-Over-Year (YOY) is a frequently used financial comparison for comparing two or more measurable events on an annualized basis.
Looking at YOY performance allows for gauging if a company’s financial performance is improving, static, or worsening. For example, in financial reports, you may read that a particular business reported its revenues increased for the third quarter, on a YOY basis, for the last three years.
The yearly rate of return method, commonly referred to as the annual percentage rate, is the amount earned on a fund throughout an entire year. The yearly rate of return is calculated by taking the amount of money gained or lost at the end of the year and dividing it by the initial investment at the beginning of the year. This method is also referred to as the annual rate of return or the nominal annual rate.
Yield refers to the earnings generated and realized on an investment over a particular period of time. It’s expressed as a percentage based on the invested amount, current market value, or face value of the security.
Yield includes the interest earned or dividends received from holding a particular security. Depending on the valuation (fixed vs. fluctuating) of the security, yields may be classified as known or anticipated.
A bond bought at a discount from its face value which offers the entire payment at the time of maturity. Unlike other bonds, it does not make periodic interest payments, hence the name ‘zero coupon bond’.
Zero-sum is a situation in game theory in which one person’s gain is equivalent to another’s loss, so the net change in wealth or benefit is zero. A zero-sum game may have as few as two players or as many as millions of participants. In financial markets, options and futures are examples of zero-sum games, excluding transaction costs. For every person who gains on a contract, there is a counter-party who loses.