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Investment Glossary

If a term is not here and you want it explained, email us and we will add it and let you know.

 

People new to the world of investing often find the vocabulary and language used to be strange and confusing. Here we have noted some of the more common words and phrases.

 

Active Funds

An active fund is run by a manager who personally selects stocks on the basis that his collection, and his allocation to each, will deliver a better return than the market. Some do and some don’t. The risk incurred in securing those returns from just 70 to 100 stocks out of a stock market of 700 needs to be considered. See tracking error.

Alpha

Alpha is a measure of how much value is added to a fund. An alpha of more than one indicates that the fund has performed better than its benchmark.

Annual Management Charge (AMC)

This is the fee that the manager of the fund charges the investor to cover the cost of running the fund. The main items are the back office costs of maintaining records and sending out statements, dealing, accountancy, compliance technology and wages. AMCs may also include an element of trail commission; this is an annual fee that goes to the person who sold the fund to the investor in the first place. AMC’s for retail funds can range from 0.5% to 2.0%.

Bear Market

A falling stock market.

Benchmark

A benchmark is usually a well known stock market index like the FTSE 100 or the FT All Share. Funds often refer to their performance relative to their chosen benchmark. Unless a fund can outperform its benchmark it is not adding any value, or alpha.

Beta

Beta is the technical term for the stock market return as a whole. If your fund goes up or down exactly in line with the market it has a beta of 1. If it is more volatile than the market, in other words if it goes up more when the market goes up but down more when the market goes down it will have a beta of greater than 1. Conversely, a fund with a beta of less than 1 will rise less when the market goes up and fall less when the market goes down.

Bull Market

A rising stock market.

Cash Flow

Cash flow is a measure of the cash generated by a company during a specified period. Operating cash flow is the number most often referred too and is the amount left after the company has paid the bills needed to run itself, but does not include tax or the capital expenditure required to maintain or expand the business.

Collective Investments

An investment vehicle that pools investments in publicly traded assets to reduce risk and enhance investment returns. The most common are investment trusts, unit trusts and OEICS.

Dividend

A dividend is the money paid out to shareholders by a company. It is the surplus cash generated by the company after paying all its bills and retaining enough to ensure it can grow in the future. It is usually expressed as figure per share but the total amount paid out by the company is the significant number.

Dividend Cover

The number of times a dividend is covered by earnings per share. A company earning 10p a share and paying out 5p in dividends would be said to have a dividend cover of 2.

Earnings

Earnings are the net profits reported for a period after all charges. It is a number agreed by accountants and directors and is a measure of the wealth generated by the company. It is not the same as the cash earned by the company and is often adjusted to allow for "one-off" factors that can make comparisons difficult.

Earnings Per Share (EPS)

Earnings per share are the net earnings a company has generated in a specified period divided by the shares in issue during that period.

FTSE 100

This is the index most commonly referred to in the news and consists of the 100 largest companies listed on the UK stock market measured by their market capitalisation. Its constituents are reviewed on a regular basis.

Fundamental Tracker

A fund run as a fundamental tracker will base its stock weight on the underlying fundamental financial attributes of the company and not simply its market capitalisation.

Information Ratio

This is obtained by dividing the relative performance, or alpha, by the tracking error. This gives a measure of how much additional performance is gained for a unit of risk. Clearly, taking big risks in a fund should be rewarded by big returns. If not then the investor is not being compensated for his deviation from the benchmark

Initial Commission (IC)

This is the fee charged by the seller of the fund to the investor. It can be as high as 5%, but is often waived for larger sums. It is a one-off fee. However, if a manager or an investor changes from one fund to another it is likely that another IC will be charged. If done too often, known as “churning”, it can have a significant impact on performance.

Investment Trust

A listed company holding shares in other companies. These are the oldest form of a collective investment vehicle.

Market Capitalisation.

This is the value the stock market puts on a company. It is calculated by multiplying all the shares in issue by the latest share price.

OEIC

An Open Ended Investment Company. Similar to a unit trust but with one price for buying and selling.

Share

A unit of ownership of a company listed on a stock exchange. Dividing the ownership of a company into small units enables it to raise capital and spread risk.

Sharpe Ratio

Developed by William F. Sharpe, this calculation measures a ratio of return to volatility. It is useful in comparing two portfolios or stocks in terms of risk-adjusted return. The higher the Sharpe Ratio, the more sufficient are returns for each unit of risk. It is calculated by first subtracting the risk free rate from the return of the portfolio, then dividing by the standard deviation of the portfolio.

Using Sharpe ratios to compare and select among investment alternatives can be difficult because the measure of risk, portfolio standard deviation, penalizes portfolios for positive upside returns as much as the undesirable downside returns.

The Sharpe ratio is calculated as follows:

   Sharpe = Excess_return / AnnualiSed_standard_deviation_of_returns

which gives you the Sharpe Ratio of the past returns over the past 24 months.

Total Expense Ratio (TER)

The total expense ratio is the total cost incurred by the investor in holding the investment and includes the initial commission, the annual management charge and any other costs incurred.

Tracker Funds

A tracker fund, often also known as a passive fund, seeks to emulate as closely as possible the underlying index it is tracking. This process is entirely automated and is a low cost, low risk way of running a fund. It allows investors to easily secure the returns of the asset class, the stock market. Of course it can be subject to fashion as the fund simply bases its weighting on the existing market capitalisation of the companies in the market. As sectors or companies become larger and larger index funds are obliged to direct more and more money towards them.

Tracking Error

Tracking error is a measure of how much risk a fund is taking to secure additional performance. It is calculated by measuring how different the fund is from the underlying market.

Trail Commission

Trail commission is the fee paid every year by the investor to the broker, IFA, bank or any third party that sold the fund to the investor in the first place. It is usually included in the AMC and is not detailed separately. Trail commission is typically 0.5% but can be lower and in some cases may not be charged at all. Although it is not a large number over a number of years the impact of compound interest means it can have a significant effect on performance.

Treynor Ratio

The Treynor ratio is another measure of risk adjusted returns and is calculated as:

(Average Return of the Portfolio - Average Return of the Risk-Free Rate) / Beta of the Portfolio

Unit Trusts

A collective investment scheme which pools your money with that of many other investors. Your return depends on how many units in the overall fund you have bought.

Weight

The weight of a stock in a portfolio is the percentage it makes up of the whole portfolio.

Yield

This is the calculated by dividing the income of an asset by its capital value. In the case of shares it means dividing the dividend by the share price and for property the rent by the current value of the house.

Yields of most assets are usually close to the prevailing interest rate.