A style of investment management that seeks to attain returns above a set benchmark by constantly monitoring, and if necessary changing, asset allocation and security selection. This is a contrasting approach to index management, where a manager will buy, sell and hold securities in order to replicate characteristics of an index.
The ‘risk’ a manager takes relative to a benchmark.
Active risk comes from an investment manager taking different positions to the benchmark, in order to outperform the market return. The greater the active risk, the greater the chance that returns will deviate from the benchmark.
The excess return of the portfolio relative to the return of the benchmark index is a fund’s alpha.
The geometric average return earned by an investment each year over a given time period. It is based on performance periods of length greater than or equal to one year.
The apportioning of a portfolio’s assets between different asset classes and/or markets, with the aim of balancing risk and reward according to an investor’s goals. For example, a fund may hold a combination of shares, bonds and cash.
An asset class’s weighting may change depending on the investor’s objective and the investment outlook at the time.
A group of securities that exhibits similar characteristics. The most common asset class groupings are:
A measure equal to 1% of 1%, or 0.01%.
A standard against which the performance of a security, managed fund or investment manager can be measured. Benchmarks are generally broad market indices like S&P Indices, Australian Stock Exchange (S&P/ASX) or MSCI Indices to which investment returns are compared.
A quantitative measure of the covariance of a given stock, managed fund, or portfolio relative to the overall market (normally represented by a benchmark). A beta above 1 means the instrument moves more than the overall market, while a beta below 1 means it moves less than the overall market. E.g. If a security has a beta of 1.1 to the overall market, and the market moves 10%, the security would be expected to move 1.1 X 10% = 11%.
An investment approach focused on the details of the individual company itself and deemphasizes the significance of economic cycles and market cycles. An investor taking a bottom-up approach may value an investment based on features such as the company’s cash flow, leverage and valuations.
See also Top down investing.
A capitalization-weighted index is one in which the components are weighted according to the total market value of their outstanding stock.
Commodities are physical resources. Professional investors typically buy or sell on the market via derivative contracts such as futures, rather than trading the underlying physical commodity. Examples of commodities include oil and gas, metals and agricultural produce such as beef, milk or grains.
Correlation (Correlation Coefficient)
Correlation looks at how individual securities or asset classes, move relative to one another. Correlation values range between -1 and 1. A correlation between 0 and 1 implies a positive relationship; correlation between -1 and 0 implies a negative relationship; while a correlation of 0 implies no relationship.
If two investments (X & Y) are highly correlated they will move in tandem. A correlation of 1 implies that a 3% movement in asset X will be concurrent with a 3% movement in asset Y, indicative of a strong positive relationship between the two, possibly driven by similar impacts.
A strategy to manage the risk of fluctuation in asset value through currency movements. Currency hedging is typically implemented using derivatives such as forwards or futures.
The risk of loss caused by adverse currency movements. This can happen when a fund is priced in one currency, but invests in assets that are priced in another currency.
Current portfolio yield
The market value weighted average current coupon of the bonds in the portfolio divided by the current market price of the bonds in the portfolio.
A financial instrument that derives (hence its name) its value from the price of a physical security or an index.
A developed market is country that is highly developed in terms of its economy and capital markets. Developed markets typically include industrialised countries with relatively stable economies and strong metrics for gross domestic product (GDP) and gross net product. People living in developed markets usually have higher incomes, higher standard of living and enjoy better infrastructure and legal systems.
In finance, diversification is the process of allocating capital in a way that reduces the exposure to any one particular asset or risk. A common goal of diversification is to reduce security-specific risk (also known as idiosyncratic risk) by investing in a variety of securities.
A payment made to shareholders by a company, as a share of its profits.
A dividend yield is a measurement of how much of its profit a company pays out to its investors every year relative to its share price. The dividend yield is calculated by dividing the annual amount of dividends paid each year by the current share price.
A drawdown is the decline, from the highest peak to the lowest trough, of an investment during a specific period.
Dynamic asset allocation
An investment strategy that involves rebalancing the mix of assets in a portfolio back to its long-term target to more effectively meet the investors risk and return objectives.
A measurement used by analysts measuring how much a company’s income has or is likely to grow over a set period of time.
Earnings per share (EPS)
The profits made on each share of a company, calculated by dividing a company’s net income by the number of shares.
An emerging market economy (developing market) tends to refer to an economy that is progressing toward becoming more advanced (developed), usually by means of rapid growth and industrialization. These countries experience an expanding role both in the world economy and on the political frontier. They tend to have low but growing measures such as GDP or GNP.
Emerging markets often appeal to investors looking for growth opportunities. However, their financial and legal systems are generally less mature, posing additional risks for investors.
Shares (ownership) of a company. Having equity in a business gives you voting rights at a company’s annual general meeting. Equities are a measure of the firm’s value.
Exchange traded fund (ETF)
An investment product that tracks an index, commodity or basket of assets in a similar manner to an index managed fund, but trades like a stock on an exchange.
The common name for a Managed Investment Scheme (MIS).
Fund dividend yield
Fund dividend yield is the dividends received by the fund from its investments, divided by the market value of the fund, expressed as a percentage.
Fund of funds
A managed fund with a strategy to invest in a variety of other managed funds, instead of directly in shares, property, bonds or cash. Fund of funds allows investors to gain exposure to a wide range of investments for a relatively small amount of capital. This can allow them to achieve greater diversity in their investments and help reduce risk.
Futures are financial contracts which give an investor the obligation to buy or sell an asset like a bond, equity, derivative or commodity, at a prearranged time and price. Futures contracts are typically “cash settled”, not settled via exchange of the underlying physical investment from which its value is derived.
Investors can use futures either to speculate on how much the price will move later on, or to hedge a future price to reduce risk.
Investors looking for investments with prospects for capital appreciation through growth in their business. Growth investors may therefore pay relatively more per unit of current earnings on the expectation that its earnings will increase in future.
A hedge is an investment made in one asset to reduce the risk of adverse price movements in some other asset. Normally, a hedge consists of taking an offsetting position in a related security.
Bonds are essentially a loan given by an investor to a company or the government, with the promise of regular interest payments throughout the loan and a repayment of their principal at the end. Bonds have credit ratings, which assess the likelihood of the borrower being able to repay the loan.
High-yield bonds typically carry higher risk of the borrower defaulting, (lower credit rating) but pay a higher yield than investment-grade bonds like government bonds.
All the assets found in a fund. This includes all shares, cash and other financial instruments.
The proportion of income given to unit holders of Managed Investment Schemes (MIS) or funds depending on the number of units they hold in the fund.
A representative measure of the value a securities market or a section of that market. Each index has its own calculation methodology and is usually expressed in terms of a change from a base value. Equity and fixed income market indices are used as the benchmark for index managed funds and ETFs, whose portfolios aim to mirror the components of the index.
An investment management approach, generally adopted by exchange-traded funds, where a manager manages a fund so that it reflects the market index, rather than trying to outperform it. Also known as passive management. See also active management.
A measure of the increase in prices of a basket of goods and services over time. Defined as the Trimmed Mean Consumer Price Index (CPI), as published by the Australian Bureau of Statistics.
A measure of risk-adjusted return of a portfolio (or security) against a benchmark. An information ratio (IR) is a portfolio’s excess returns (ER) above a benchmark (such as an index) per unit of tracking error (see tracking error, TE).
IR = ER / TE
Information Ratio is a measure of efficiency in generating excess return, expressing an investment manager’s performance relative to the level of benchmark-relative risk they took to generate that excess return.
A range of investments with similar features – for instance, specific commodities, investments in the same index or market, or that have the same market capitalisation. A managed fund often has an investment objective to invest in a particular investment universe.
This is a term used to describe an investor's ability to convert a particular product into cash. A product which has high trading volumes and is easy to buy and sell is typically considered highly liquid.
The behaviour and drivers of an overall economy such as inflation, interest rates, unemployment, national productivity and other large-scale factors.
Managed Investment Schemes (MIS)
Also known as a managed fund, pooled investment or collective investment. Managed Investment Schemes (MIS) can be shares, property trusts, cash investments and so on.
These vehicles are run by professional investment managers (also known as ‘the responsible entity’).
MIS allow investors to pool their money with other investors. This gives investors exposure to professional skill and a wider range of investments than they could access independently.
The market value of a company’s available shares, calculated by multiplying the total number of shares on issue by its current share price.
Market risk is the possibility for an investor to experience losses due to factors that affect the overall performance of the financial markets (as opposed to factors that only affect the individual securities held). Market risk, also called "systematic risk," cannot be reduced through diversification with the asset class.
NAV or net asset value
The net asset value of a fund is the value of all assets less liabilities.
An investment instrument that gives investors the right (but not the obligation) to buy or sell a particular asset at an agreed price.
A portfolio or fund that has a greater percentage weighting in an asset class, sector, geographical region or stock than the index or benchmark that it is measured against is considered ‘overweight’ that asset class, sector, geographical region or stock etc.
Passive portfolio management
See Index management.
The PB ratio is the current market price of the stock divided by the most recent reported book value for the prior fiscal year.
The price to cash flow ratio is the current market price of the stock divided by the cash flow per share as of the last fiscal year as of the report date.
The PE ratio is the measure of the current share price relative to the annual net income earned by the firm per share. PE ratios can be based on actual historical earnings or forward estimates of earnings.
A “quality” style of investing emphasizes companies considered to be of higher quality within the investible universe. While there is no universal definition of ‘quality’, generally accepted metrics include a combination of high return on equity, stable earnings/return on assets, and low financial leverage.
Return on equity
The weighted average of the rate of return for each security in the fund.
A security is a financial contract, issued by a company or government. It represents:
A measure of risk-adjusted return. It is calculated by dividing the fund’s excess return above the risk-free rate by its standard deviation. The higher a fund’s sharpe ratio the better its returns relative to the amount of overall investment risk it has taken.
A measure of historical volatility (or historical risk) which quantifies the amount of variation or dispersion of a set of returns (or values).
Strategic asset allocation
A long-term allocation of a fund across a variety of asset classes. Portfolios are usually kept close to their strategic asset allocation, though if permitted by the fund, short-term tactical deviations may be taken with an aim to profit from risk or return opportunities.
A derivative in which two counterparties exchange cash flows of one party's financial instrument for those of the other party's financial instrument. The cash flows are calculated over a notional principal amount. The notional amount is usually not exchanged between counterparties.
Tactical asset allocation
A short-term deviation from a long-term strategic asset allocation with the goal to improve the risk and or return profile of the fund.
An investment approach that focuses on macroeconomic factors, such as the performance of the overall economy.
Also known as active risk, tracking error is a standard deviation-based metric which indicates how closely a portfolio follows the index to which it is benchmarked.
A tracking error of x% means that two-thirds of the time over a one-year period a fund should be within +/- x% of the benchmark return.
Index management attempts to minimise tracking error by replicating the benchmark as closely as possible.
Defined as the accessibility of information on the order flow for a particular stock, allowing knowledge of the quantities of stock being offered and the bids at the various price levels.
A portfolio or fund with a lower percentage weighting in an asset class, sector, geographical region or stock than the index or benchmark that it is measured against.
An investment strategy focusing on companies whose shares appear under-priced relative to its perceived fundamental value. If all stocks are ranked from lowest to highest by some metric, such as price-to-book or price-to-earnings ratios, portfolios with low levels of the ratio have more value characteristics than portfolios formed from higher levels of the ratio.
A statistical measure of the fluctuations of a security’s price. Generally, high volatility can be an indication of higher risk
This is the measure of the amount of shares or number of units of a particular security traded over a given time period. Volume is a useful measure of the liquidity of a security.
The amount of income earned on an investment, the most common way of measuring yield is: