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INVESTMENT DICTIONARY II As is the case in many industries, the ever complex world of is full of jargon. Although it is the role of specialists to use clear language rather than technical terms, sometimes these are just unavoidable. To help trustees in their understanding and interpretation of the investment terms that they may encounter in their day-to-day responsibilities, Mercer has compiled this Investment Dictionary. A number of the terms have other non-investment related meanings, which we have not captured. The dictionary is intended to supplement rather than replace expert investment advice. We have expanded this year’s edition of the Investment Dictionary by introducing several terms since our last update in 2012 that cover industry updates, as well as other terms not covered previously. The additions reflect the ever-changing face of investment markets, with the associated phraseology that this introduces. They also represent our efforts to continue to raise the level of knowledge of trustees, thus better equipping them to fulfill their fiduciary duties. In certain cases we have specified that terms relate to a particular class. Readers should be aware that such terms might have a different meaning in general usage or when applied to other asset classes.

1 401(k) plan accrued Interest that has been earned but not yet US-defined contribution plan offered received. The purchaser of a in the by a to its employees, which pays the seller the of the allows members to set aside -deferred accrued interest, as the former will receive income for purposes. (The the full when it is next paid. name 401(k) comes from the IRS section describing the programme.) ACT See Advance Corporation Tax.

Approach to which aims to outperform a particular A market or benchmark through and/or selection decisions. (See also enhanced indexation, passive AAA management.) Highest rating assigned by a number of rating agencies, indicating the active relative of an of . Difference between the actual level of Usually accorded to quasi government and investment made in a particular or large multinational corporate borrowers. asset class and the benchmark allocation vehicles/strategies or weighting of that investment. Investment strategies targeting a positive active return return in absolute terms rather than Increase in the on a relative to an index or other benchmark. from active management. These strategies avoid construction limitations imposed by the measurement active against a specific benchmark. Often also Risk measured in terms of of a referred to as plus funds. (See also portfolio’s return compared with that of fund.) the benchmark return, arising from active management. Some level of active risk is accrued benefits necessary to achieve active return. (See Benefits that an employee has earned also .) to date based on his or her membership of a scheme. Accrued benefits are activism often calculated in relation to the Intervention by using their employee’s and completed . rights to influence the actions of corporate management with a view to

enhancing the value of the .

2 A actuarial assumption agency Estimate made for the purposes of an Broker/dealer who acts as between actuarial . Possible variables market makers and . include life expectancy, return on agency , interest rates and growth in Undertaken on behalf of the client on a earnings. (See also actuarial valuation.) best endeavours (and best execution) actuarial valuation basis. The client bears the risk ( or Professional assessment undertaken by an loss) of movements between giving to determine whether the of and completing the order. a plan are likely to be sufficient to meet the AIM accrued benefits; normally carried out at See Market. least every three years, in line with legislative requirements. AIMR Association for Investment Management actuary and Research. See CFA Institute. Professional who advises on financial issues relating to , and All- Index mortality, most frequently in relation See FTSE All-Share Index. to the financing of pension plans and . ALM See asset/liability modelling. additional voluntary contributions (AVC) Contributions over and above a member’s Incremental return added by an contractual contributions to a pension investment manager through active plan, enabling him or her to accrue management. additional benefits. alpha transfer adjustable-rate mortgage (ARM) combining active Mortgage whose is raised management in one asset class (the alpha) or lowered periodically in accordance with with strategic exposure to a different a stated reference interest rate. ARM refers underlying asset class. both to the original homeowner loan and Alternative Investment Market (AIM) to a securitised pool of such . Market operated by the London Stock ADR Exchange for smaller companies. The See American Depository Receipt. requirements and of are less onerous than on the main . Advance Corporation Tax (ACT) Tax formerly paid by companies on distributed to shareholders.

3 alternative investments (APR) Investments that do not fit into the of debt that is paid by borrowers, mainstream areas of equities, bonds and expressed as an annualised figure. property, and which would normally only annualised return form a small proportion of pension plan Periodic converted into an portfolios. Examples include private equivalent one-year rate of return. For /venture , hedge funds and example, a return of 75% earned over five . They are typically brought years converts to an average annualised into a portfolio to increase diversification. return of 11.8% per year. AMC annuity Annual management charge. Contract designed to provide regular See management charges. payments to the policyholder in return for American Depository Receipt (ADR) an initial lump sum payment. Annuities Security issued by a US to represent may have a guaranteed period and/or be shares of a foreign (i.e. non-US) company, payable for life. Payments may be fixed or which can be traded on a US stock may vary. exchange as if they were American APR securities. Similar securities are available See annual percentage rate. on other stock markets. American Stock Exchange (AMEX) Risk-free profit derived from differences Stock exchange for certain US not in price when the same or equivalent listed on the investment is traded on two or more (NYSE). AMEX stocks tend to be smaller markets or in more than one form. By than those listed on the NYSE. taking advantage of price disparities American-style between markets, arbitrageurs perform Option that can be exercised at any the economic function of making these stage during its life, at or before markets trade more efficiently. date. The value of an American-style option will always be greater than or Option whose price at expiration depends equal to the value of a similar European- on the average value of the underlying style option. asset over the life of the option. amortisation ask price Repayment by instalments over a period Lowest price for which an or of time. dealer will sell a given security or analyst . Also called offer price. See investment analyst.

4 A asset asset stripping Anything that has a monetary value. Process of splitting up and selling parts of a separately for asset allocation profit-making purposes. of investments across categories of assets, such as cash, asset equities and bonds. Asset allocation The exchange of a flow of payments from affects both risk and return and is a a given security (the asset) in return for a central concept in financial planning different set of cash flows. and investment management. Association for Investment asset-backed security Management and Research (AIMR) Security backed by a pool of notes or See CFA Institute. receivables against assets of a similar at par type, such as receivables. Having a current price equal to face or asset carry . Return associated with holding an asset, at-the- if positive (e.g. interest earned by the holder Indicates that a traded option has no of bond), or the cost of holding intrinsic value (positive or negative), an asset, if negative (e.g. warehousing costs i.e. the underlying is equal to of holding commodities). the . asset class attribution Broad category of assets of a similar type See performance attribution. — for example, equities, bonds, property and cash. Unbiased examination and opinion of asset/liability modelling (ALM) the financial statements of an organisation. Projection of future movements in assets It can be internal (by employees of and liabilities, and especially the the organisation) or external (by an relationship between the two. ALM is used outside firm). to provide an insight into the likely effect of different asset allocation strategies on a authorisation pension scheme’s future financial position. Required by the Financial Services and (See also stochastic modelling.) Markets Act 2000 for any firm or individual who wants to conduct investment asset manager business in the UK, unless the firm is Firm or individual who manages (i.e. buys exempt from under the Act. and sells) a portfolio of assets.

5 authorised backwardation Nominal amount of share capital that a Situation where the price for future company is authorised to issue, in terms of delivery of a commodity in a forward its articles of constitution. contract is less than spot price of the commodity. (See also .) authorised unit which has been authorised by the FSA. (See also unit trust.) Debt which is viewed as unlikely to be recovered by the creditor and may be Autorité des marchés financiers (AMF) written off as worthless. French regulatory body tasked with improving the efficiency of France’s balanced management financial regulatory . Its three main Where an investment manager is given functions are to protect investor , broad discretion in relation to the to set standards for the provision of management of all the main asset classes. investor-related information and to marshal (See also specialist management.) the functioning of financial markets. AVC Legally declared state that is usually See additional voluntary contributions. triggered by a company’s failure or (See also FSAVC.) impaired ability to meet its contractual debt obligations. Usually results in average daily volume of portfolio restructuring of the company’s debt or Weighted sum of the quantity of each asset liquidation of the company. (See also to be traded divided by that asset’s distressed debt.) average daily traded volume. barbell strategy

Investment technique, typically related to

a bond portfolio, under which a manager

holds a combination of both shorter-dated

and longer-dated bonds relative to the

B benchmark, but where overall duration is broadly in line with the benchmark. back office bargain Administrative activity related to Another word for transaction or deal. It investment management, for example, does not imply that a particularly , pricing and plan . favourable price was obtained. (See also front office.)

6 A B BARRA Software programs developed by Barra Bond with no central register of International and used to evaluate bondholders. Entitlement to payments of portfolio risk, chiefly in equity investments. interest and principal depends on physical of the bond. Bondholders base submit coupons to the issuer (cut out from Currency of the country in which the the bond) to receive each interest payment. investor is based. beauty parade base rate Competitive review of investment Benchmark for other interest rates, managers, custodians, consultants or including personal loans and mortgages. other service providers, usually involving The high street bank’s base rate changes written submissions and presentations. following changes made by the to its rates. The Bank of England bell curve moves base rates by changing the dealing See . rates at which it buys bills from the bellwether discount houses. The equivalent term in Stock or bond that is widely believed to the USA is the “prime rate”. be an indicator of the condition of the overall market. 1/100 of 1%, or 0.01%, thus 100bp = 1%. below par Having a current price below face or Risk that arises when an investor attempts par value. to hedge a position in the market using an benchmark instrument that has an underlying security Measure against which a portfolio’s which is different from the security whose performance, risk and construction is risk is being hedged. For example, using a assessed. The benchmark may take the FTSE 100 future to hedge a FTSE All-Share form of a market index for portfolios UK equity portfolio. focusing on a particular market — for bear example, MSCI World Equity Index — or Individual who believes that a security, be a peer group average or median. sector or the overall market is going to fall benchmark portfolio in price. Opposite of bull. Theoretical portfolio of assets against bear market which the performance of an actual Period of sustained decline. portfolio is monitored. Opposite of bull market.

7 beneficial owner bond Person who enjoys the benefits deriving Certificate of debt issued by a government from a security or property. May be or company, promising regular payments different from the legal owner in whose on a specified date or range of dates, name the title is registered. usually with final capital payment at redemption. Most bonds are issued with a best execution nominal face value and a coupon, stated as Execution of a securities transaction at the a percentage of their nominal value, best price available in the market at the although variations on this structure exist. time of the transaction. A bond’s price rises as its falls, and vice versa. (See also zero coupon bond, Statistical measure of risk or volatility. index-linked gilt, floating rate bond.) Indicates the sensitivity of a security or bond rating portfolio to movements in the market Credit rating on a bond. index. Securities/portfolios with a beta greater than one are expected to be more bond yield volatile than the market as a whole, Income of a bond as a percentage of the outperforming in rising markets and capital invested. As bond yields rise, underperforming in falling ones. fall, and vice versa. bid/offer (bid/ask) spread bonus issue Difference between the buying price (offer Issuance of free shares by a company to its or ask price) and selling price (bid price) of existing shareholders. No money changes a pooled fund unit or a security. hands and the share price falls pro rata. This is usually used as an to make bid price the shares more marketable (i.e. cheaper Price at which a security or a unit in a per share and therefore more attractive to pooled fund can be sold. (See also ask small investors). Also known as a price, offer price, mid price.) capitalisation or scrip issue. bill, treasury See treasury bill. Value at which a security is recorded on a blue chip company , usually the cost of buying it. Large, well-known company with a If securities have been acquired at different record of profit growth, strong branding times and different periods, the book value and consistent record of paying dividends. will reflect the average buying cost. boom Period of rapid .

8 B broker/dealer Method of interpolating government bonds Individual or firm that acts as an of differing maturities to gain exposure intermediary between buyers and sellers, evenly across the whole . usually for payment of a commission. It may also buy securities to sell for a profit bottom quartile while fulfilling its role as dealer. Quartile ranking that is in the bottom 25% of returns. (See also top quartile.) bull Individual who believes that a security, bottom-up sector or the overall market is going to rise Approach to active investment in price. Opposite of bear. management that gives priority to the identification and selection of companies bull market (with less emphasis accorded to sector and Period of sustained stock market growth. geographical region) to build up an Opposite of bear market. investment portfolio. This is the opposite bullet portfolio of a top-down approach. (See also country Bond portfolio with maturities allocation, stock selection, top-down.) concentrated over a small cross-section bourse of the yield curve. Another name for a stock exchange; usually applied in a Continental European context. See economic cycle. boutique investment manager analysis Firm, generally relatively small in scale of Technique of investment performance operations, which has as its sole purpose measurement which compares a portfolio the management of investments for third and its related characteristics (return, parties for a fee and which does not income, yield, volatility) at the end of a participate in other activities such as period with the portfolio as it would have banking or life assurance. been had no transactions occurred during breakeven the period. This separates the effects of The rate of inflation that will equalise the market movements and manager decisions. returns between fixed interest and buy and hold strategy inflation-linked securities of the same Investment strategy in which stocks . For example, if the yield on a are bought and then held for a long 10-year fixed interest gilt is 5% and the real period of time regardless of -term yield on a 10-year index-linked gilt is 2%, market movements. then the breakeven inflation rate is 3%. Also known as implied inflation and can be derived from swaps as well as bonds.

9 capital adequacy Firms conducting investment business are C required to have sufficient funds of their own. The European Union Capital Adequacy Directive, which sets minimum levels of CAC 40 index capital for UK financial service companies, Paris-based of the came into effect on 1 January 1996. leading 40 French shares. capital model (CAPM) call for valuing assets. Requirement for an investor to make The simplest version states that the additional payments on specified dates in expected excess return of a security order for an investment (e.g. a partly paid over a risk-free asset will be exactly in stock or an optional ownership) to be fully proportion to its beta. paid up. See flight to quality. Option which gives the purchaser the right, but not the obligation, to buy an (CGT) asset at a specified price either on an Tax levied upon the sale of an asset, based agreed date (European option) or on or on the increase in its price since purchase. before an agreed date (American option). Tax-approved UK pension funds are This date is known as the expiration date. exempt from CGT. (See also .) capital growth Appreciation in the capital or Bond which can be redeemed before of an investment, as opposed to income maturity at the option of the issuer. (e.g. dividends) which may be received from the investment from time to time. cap Interest rate contract where the purchaser receives from the seller, at the end of each Any upon which securities period prior to expiry of the contract, the are traded. difference between current interest rates capitalisation issue and a strike interest rate, should interest See bonus issue. rates rise above the strike. For example, agreement to receive money for each capitalisation-weighted index month during which LIBOR exceeds 5%. Index where the weightings applied to (See also floor.) each component security are based on their relative market capitalisations. (See also equal-weighted index.)

10 C CAPM Central Counterparty House See capital asset pricing model. (CCP) An organisation that helps facilitate CAPS trading done in derivatives and equities See Mellon Analytical Services. markets. There are two main processes carry that are carried out by CCPs: clearing and See asset carry. settlement of market transactions. carry trade certificate of (CD) Practice of borrowing in with Tradable certificate showing that a particular low associated yields and lending in sum has been deposited with a bank for a high-yielding currencies. If currency certain time at a certain interest rate. CDs markets are efficient, there should be no are non-interest bearing and are quoted at a gains to the , since the yield discount to their par redemption value. differential will be offset by changes in the CDO relative exchange rates. See collateralised debt obligation. carried interest CFA® Mechanism by which a See Chartered . manager shares in the profits achieved in a private equity fund or investment. CFA Institute Typically, the carried interest will be International non-profit organisation around 20% of the gains achieved. composed of more than 90,000 individual voting members and 136 non-voting risk member societies whose mission is to set a Risk that an investor scheme is forced to higher standard of professional excellence sell assets to meet liabilities. This can occur for the investment profession. Individual when the level of cash flow required to members either hold the CFA designation meet benefit payments exceeds the or are active in the investment business contribution and investment income. and agree to abide by the CFA Institute CBO ethical requirements. The CFA Institute Collateralised bond obligation. administers the CFA Examination and is See collateralised debt obligation. responsible for the Global Investment Performance Standards (GIPS™). central clearing Previously called the Association for Process designed to reduce counterparty Investment Management and Research risk which is present in bilateral over-the- (AIMR). (See also GIPS, UKIPS.) counter by clearing with a single central counterparty. CGT See capital gains tax.

11 Chartered Financial Analyst (CFA®) clean fees Qualification awarded by the CFA Institute. All-inclusive fund management fees, to Its curriculum develops and reinforces which no additional charges (e.g. custody, fundamental knowledge of investment administration) will be added. principles. Examinations measure a cleantech candidate’s ability to apply these Products, services and processes geared principles at a professional level. towards reducing or eliminating the (See also CFA Institute.) environmental impact of a means of chartism . May include investments in Form of where charts agriculture, energy, , are used to identify trends and study materials, technology, transportation movements in share prices or financial and water. and economic indicators, with the aim of predicting future (often short-term) positioned between two changes in stock market prices. respective counterparties and responsible Chinese wall for the trade settlement, thus removing Separation of activities in a financial counterparty risk from both parties. institution to prevent confidential and/or closed-end fund price-sensitive information from passing Collective investment schemes that issue a from one area to another. For example, it is fixed number of shares which are then normal practice for a financial services usually traded on a stock exchange. The institution to separate , price of each share is determined by stockbroking and fund management using and demand in the . Chinese walls. The share price may stand at either a churning discount or premium to the Excessive trading of an investor’s portfolio. of the underlying investments. Investment Sometimes used unethically to generate trusts are examples of closed-end funds. extra commissions. (See also open-ended funds.) CIF closet indexing See common . Running of an “active” portfolio by an “active” fund manager where the fund’s circuit breaker holdings are insufficiently different from Stock exchange rule or other action the composition of the index for the fund’s designed to maintain orderly trading performance to deviate significantly from during periods of market, for example by the index. preventing computer-generated trades from sending the market into a downward spiral.

12 C closing price collateralised mortgage obligation Price at which the final market transaction (CMO) in a security took place on a particular Security that pools together mortgages business day. and separates them into paying different rates of interest, depending on coattail investing their terms to maturity. In most CMOs, in which investors coupons are not paid on the final duplicate the performance of a successful until all other tranches have been (and usually well-known) investor by redeemed (the coupons are added to the copying his or her trades as soon as they capital outstanding in the interim). Such a are made public. This is a risky strategy, as tranche is called an accretion bond, an there is a time delay between when the or a Z-bond. successful investor’s trades occur and when they are made public. Combined Code Code of good practice in corporate hedge in the UK, set out in the Investment strategy obtained through a Cadbury, Greenbury, and Hampel and combination of put and call options. This Higgs reports. Among other things, the option-based strategy results in stabilised Code refers to institutional shareholders, portfolio returns by obtaining protection encouraging them to take responsibility against a major decline in portfolio value in for voting and, where appropriate, to enter exchange for the sacrifice of part of the into dialogue with the companies in which portfolio’s appreciation in a major . they invest. collateral commercial mortgage-backed security Assets placed on deposit as security for an (CMBS) open position (e.g. loan, swap, short sale), Mortgage-backed security collateralised which may be used to offset the potential by commercial rather than residential loss by a counterparty should the first mortgage loans. Unlike residential MBSs, party on its obligation. CMBSs are not usually subject to collateralised debt obligation (CDO) prepayment risk, as most underlying loans One of a series of bond-type investments, do not permit prepayment without backed by a pool of assets, such as loans or substantial penalties. mortgages, which can be tailored to match one or more investor’s requirements in Unsecured short-term debt issued by terms of credit rating, risk, duration, , and other borrowers. timing of payments, etc. commingled fund See pooled fund.

13 commission compressed valuations Fee paid to a for buying Market conditions in which relative pricing or selling a security, usually calculated differences between the highest- and as a percentage of the value of the lowest-priced segments of a stock market security. Commissions vary across are smaller than the long-term average. markets and between . Typically favours growth investors, since (See also soft commission.) faster-growing stocks will be trading at a lower-than-normal premium to the commission recapture market. Value investors, on the other Facility whereby a network of brokers hand, will struggle to find stocks trading at agrees to rebate a portion of commissions deep discounts to the market. to clients. This is usually managed by a third party that leverages collective concentrated portfolio clients’ buying power. Portfolio with a small number of securities. This relative lack of diversification aims to commodity achieve higher performance than the Any raw material — examples include oil, benchmark but with a commensurate and cattle. increase in risk. common investment fund (CIF) consensus fund Pool of assets from more than one entity Form of that aims to invested under one investment vehicle. match closely the average return achieved by a specified group of actively managed US name for ordinary shares. portfolios. These funds usually operate by continually adjusting their assets to bring compound interest them into line with the average asset mix Method of accumulating interest, where of the specified portfolios and then by interest is paid on both the initial investing, within each area, in securities investment and the interest accruing that represent the market index. during the period. consideration Something of value, such as money or Option where the underlying asset is itself personal services, given by one party to an option. another in exchange for an act or promise. compound rate of return Total return calculated by multiplying Process where a company increases the returns for different periods. nominal value of its shares, and decreases the number of shares in issue by combining multiple denominations. For example, consolidating five shares of 5p each into one share of 25p.

14 C constraints Limits or restrictions imposed on an Bond which, under certain conditions, investment manager in relation to the owner can opt to convert into another particular shares, sectors or markets for security, normally an ordinary share. various reasons, for example, risk convexity reduction or ethical considerations. Measure of the way a bond’s duration Price Index (CPI) changes in response to a change in US measure of price inflation. interest rates. Positive convexity is evidenced when the proportional change Consumer Prices Index (CPI) in a bond’s duration is greater than the Measure of price inflation in the UK. Differs proportional decrease in interest rates, from the RPI in the particular it and vice versa for negative duration. represents, the range of and services included, and the way the index is core holding constructed. Compiled by the Office for Security or asset which is considered to National and used for the UK be a long-term holding in a portfolio and, government’s inflation target. The UK as such, is less likely to be actively traded. government’s name for the Harmonised They are often high-quality securities with Index of Consumer Prices (HICP), a a history of fairly steady performance. standardised European-wide measure core/satellite of inflation. See( also Prices Index.) Generally, the partitioning of a plan’s contango assets between a core portfolio of lower In a , the situation where risk holdings (which may be managed the price of a commodity for future delivery passively) and one or more actively exceeds the spot price of the commodity. managed (satellite) portfolios. The difference is considered to indicate the cost of holding the physical asset for future Bond issued by a corporation (as delivery. (See also backwardation.) opposed to a government) promising contract note regular payments on a specified date or Written record of an agreement to buy or range of dates and a final capital payment sell securities. at redemption. contrarian Investor who takes a position in the market Means by which shareholders govern the contrary to that of the majority. management of a company through the use of voting powers. Also used more conventional bond generally with regard to the by Bond where the coupon and principal which boards of directors are composed, payments are fixed. and companies are directed and controlled.

15 corporate responsibility coupon Initiative to assess and take responsibility Interest rate payment (usually six-monthly) for a company’s effects on the on a bond. environment and impact on social . covenant (bond) This goes beyond the environmental Provisions within a borrowing agreement measures required by law or by describing the obligations of a bond issuer environmental protection groups. to protect the interests of the bondholders. correlation coefficient Affirmative covenants require the Measure of the interdependence of two or borrower to take certain actions (e.g. more variables, for example, the returns retain a certain debt to equity ratio). recorded by two stock markets. A Negative covenants prohibit the borrower correlation coefficient can range from -1 from certain actions (e.g. pay out too high (inverse relationship) to +1 (perfect dividends). The breach of covenant might correlation — change in variables will be cause the default of the bond. identical). A correlation coefficient of 0 covenant () indicates the absence of a relationship Ability and willingness of the sponsor to between the variables. make good any shortfall in a scheme’s counterparty risk funding. A strong covenant reflects a Risk that the other party in a financial financially strong sponsoring company, arrangement defaults on its contractual which can be relied upon to rectify funding obligations. For example, in a swap, where shortfalls in the pension fund should they interest rates increase, the fixed rate payer emerge. This imparts a degree of in the agreement is at risk that the investment flexibility and freedom counterparty (the floating rate payer) fails lacking for a pension fund with a weaker to deliver the increased interest payment. covenant from its plan sponsor. country allocation covenant (property) Integral part of the asset allocation process Commonly used in property investment to that selects desired weightings in refer to the quality of a tenant. A tenant particular geographic regions. with a good covenant is of high quality and unlikely to break the terms of the country risk agreement, for example, the government Risk attached to investing in a given or a government agency. The covenant country that relates to the country, for also sets out the obligations of tenant and example, political and economic risks landlord. rather than other factors more specific to the investment in question.

16 C coverage credit rating Proportion of a portfolio’s benchmark that Rating given by a credit-rating agency, is actually held in the portfolio, measured based on its view of the financial strength either by market capitalisation or number of a borrower and the likelihood of default of stocks. Also refers to the researching of (i.e. inability to meet debt obligations). a particular stock by an analyst, who will The highest rating is usually AAA, and the issue reports and recommendations to lowest is D. fund managers. covered option Risk of suffering loss due to another party Option where the writer owns the defaulting on its financial obligations. Also underlying asset (of a call option) or holds known as default risk. cash of equal value to the strike value of the underlying asset (for a call option). Difference in the yield available on a CPI corporate bond compared to a government See Consumer Price Index (US measure of bond. Credit spreads will generally be price inflation) or Consumer Prices Index higher for companies with lower credit (UK measure). ratings. (See also swap spread.) credit Credit Support Annex (CSA) Debt issued by non-government bodies. Provides credit protection by setting forth the rules governing the mutual posting of credit crunch collateral. CSAs are used in documenting Describes the global financial crisis of collateral arrangements between two 2008/early 2009 which was driven by a parties that trade privately negotiated chronic lack of liquidity (credit) in financial (over-the-counter) derivative securities. markets across the world. A clean CSA is one that permits only GBP cash and UK gilts to be posted as collateral Contract between two parties who agree in GBP-denominated transactions. to exchange payments based on a contingency residing with a third party. Typically, the protection buyer will make periodic payments to the protection seller, who in turn agrees to make a contingent payment to the buyer upon the occurrence of a credit event on the third party’s asset (e.g. the third party defaulting on a loan repayment).

17 Credit Support Deed (CSD) currency hedging Annex to an ISDA Master Agreement, Strategy designed to reduce or eliminate drawn up under English law, which allows risk in a portfolio of parties to the agreement to mitigate their non-domestic assets through the use of credit risk by requiring the out-of-the- currency futures/forwards or by the money party to post collateral (usually purchase, sale or borrowing of the cash, government securities or highly exposed currency. rated bonds) corresponding to the amount currency overlay which would be payable by that party were Investment management technique all the outstanding transactions under the aimed solely at managing an investor’s relevant ISDA Master Agreement overseas currency exposure, either terminated. The equivalent agreement actively or passively. under New York law is known as the Credit Support Annex (CSA). currency risk Risk of incurring losses in the value of CREST overseas investments as a result of Real-time settlement system for trading of movements in international exchange UK and international shares, UK rates. Can also refer to the additional government and other corporate volatility caused by exposure to assets in securities. The system is operated by foreign currencies. Also known as CRESTCo. exchange rate risk. crossing Transactions undertaken directly with Effectively the exchange of two sets of cash other investors executing the opposite flows in different currencies. Involves the trade, to minimise spread costs and purchase/sale of a currency in the impact. Internal crossing market against the simultaneous opportunities are those where the purchase/sale of the same amount of the investors are simultaneously trading with a currency in the . The transition management firm. External agreed payment in each currency changes crossing involves actively seeking out hands on each swap date (unlike an market participants who are executing , where the payments are trades in the opposite direction. netted off against each other). cum curve risk Security where the purchaser is entitled Risk that changes the shape and/or slope to receive the next coupon or dividend. of the yield curve result in mismatched The opposite of ex-dividend. performance between an actual bond portfolio and its benchmark, or between assets and liabilities where these have different durations.

18 C D cushion DC In portfolio insurance products, the See defined contribution. difference between the cost of buying the DCF zero coupon bond and the principal amount See . guaranteed. (See also portfolio insurance.) custodian Loan made to a company, secured against Organisation responsible for the its assets. safekeeping of assets, income collection and settlement of trades for a portfolio; Debt Capital Markets (DCM) independent from the The environment in which the issuance function. and trading of debt securities occurs. Debt is often used as an alternative to cyclical stock financing through equity, and can add Security which is sensitive to movements diversity to funding. in the economic cycle — generally performs well in periods of falling interest debt/equity ratio rates or growth but poorly during an Company’s borrowings divided by its economic downturn. For example, issued share capital. It is a measure of the financial stocks and capital goods. See( amount of gearing () of a company also defensive stock.) and an indicator of financial strength. A company with a higher debt/equity ratio cyclical trend can offer greater returns to shareholders, Recurring movements in prices or interest but these will be more volatile than if the rates, usually linked to stages in the gearing were lower. business cycle. decile

Relative ranking (in tenths) of a particular

portfolio (or manager) in a league table of

returns. For example, a decile ranking of 1

(or “top decile”) indicates a performance

D in the top 10% of portfolios surveyed, a decile ranking of 2 (or “second decile”) DAX index indicates performance in the next 10%, Stock market index of 30 leading and so on. German shares. deep discount bond DB Bond priced significantly below face value, See defined benefit. typically a zero coupon bond or a distressed bond.

19 default defined contribution (DC) a. Failure to pay interest or principal Pension arrangement where the rate of promptly when due. contribution paid by the employer and/or b. Failure to make payments the employee is defined (usually a on a . percentage of salary). The benefits paid to c. Failure to comply with other conditions members will depend on the contributions of an obligation or agreement. paid into the plan on behalf of the member, the investment return earned on those defensive stock contributions, and the terms available at Stock which is expected to be less volatile retirement for converting the fund into a than the overall market — for example, pension. The employee/member bears the stocks. (See also cyclical stock.) investment risk in such an arrangement. deferred annuity Also known as money purchase. Annuity whose payments commence from a future date. Deferred annuities can be Decline in the prices of bought from an insurance company to — that is, the opposite of inflation. secure a pension in the future. delta hedging defined benefit (DB) Strategy for combining derivatives with Pension arrangement where the benefits holdings in the underlying assets in such a payable to members are clearly specified, way that the price of the overall portfolio usually as a percentage of salary at, or does not change with small instantaneous near, retirement. The contributions that changes in the price of the underlying asset. are required to ensure that this Used by investment banks, for example, to commitment can be met will vary risks in their derivative positions. depending on the plan’s investment and demographic experience and the benefits derivative to be provided. The employer bears the whose value is investment risk in such an arrangement. dependent on the value of an underlying index, currency, commodity or other asset. Examples include options, futures, forwards and swaps. deterministic modelling Liability-matching modelling that assumes that the liability payments and the asset cash flows are known with certainty.

20 D discount rate Formal reduction in the value of a currency Rate of interest used to convert a cash relative to other currencies or, historically, amount occurring in the future into a to the price of gold. This is different from present value. depreciation, which is the gradual discounted cash flow (DCF) reduction in the value of a currency Process by which future cash flows (for through market movements. example, dividends or interest payments) development capital are adjusted to allow for the time value Capital investment into companies which of money to arrive at a value in today’s are generally profitable but which require terms. Discounted cash flow models are further equity finance to expand. used to determine the fair value of securities, capital projects and corporate dilution entities. (See also .) Reduction in and book value per share due to an increase in the discretionary mandate number of shares issued. This can occur Instruction given to an investment if convertible securities are converted, manager, giving the manager total if warrants or stock options are exercised, decision-making authority to manage or if a rights issue or scrip issue takes place. the assets against a specified benchmark. dilution levy distressed debt Charge levied on a new investor entering Corporate debt where the originator or leaving a pooled fund to ensure that of the debt (the borrowing company) is other investors in the fund do not suffer currently in or approaching financial the trading costs of the new investor. distress, such that default on the debt has either occurred or is imminent. (See also dirty fees junk bond.) Fund management fees to which extra (often non-explicit) charges are added, diversified growth fund for example, for custody, overseas Actively managed fund designed to transactions, etc. generate investment return by investing in a range of growth-seeking asset classes, discount broker such as equities, property, commodities, Stockbroker who charges lower private equity, corporate bonds, etc. commission rates than a full service stockbroker but usually provides a more limited service.

21 diversification double tax agreements technique which Agreements between countries to offset involves spreading investments across a tax liabilities in one country against those range of different investment opportunities, in another, so that the same or similar thus helping to reduce overall risk. The will not be paid twice. risk reduction arises from the different Dow Jones index (DJIA) investments not being perfectly correlated. The Dow Jones Industrial Average index. Diversification can apply at various levels, It is the most frequently quoted measure that is, diversification between countries, of the performance of industrial stocks on asset classes, sectors and individual the New York Stock Exchange. It covers a securities. Diversification reduces both the relatively small number of leading shares, upside and downside potential and allows but nonetheless its movements can for more consistent performance under a influence other stock markets. wide range of economic conditions. downgrade dividend When a bond’s credit rating is lowered. Discretionary payment out of profits by Usually caused by an event such as a a company to its shareholders. negative trading statement by the issuer, dividend cover which in turn increases the risk that it Company’s post-tax earnings divided by might be unable to meet its future the total amount it has paid in dividends payment obligations. for a particular period. This is an indication draw down (private equity) of a company’s ability to maintain its Call on part or all of an investor’s dividend rate. outstanding commitment to a private equity fund. Model used to estimate a security’s value due diligence by performing a discounted cash flow Investigation and verification of material analysis of future expected dividends. facts regarding a proposed transaction. For example, the potential purchaser of a Return to investors represented by a company would undertake due diligence company’s dividend per share divided before completing the deal, requesting by its current share price. access from the target company to information that is not publicly available. DJIA See Dow Jones index.

22 D E duration earnings Average term (in years) of the payments Net profits of a company available for from a bond, taking into account the distribution to shareholders. present value of each payment. The longer earnings per share (EPS) the duration, the more sensitive the price Company’s annual earnings divided by the of the stock to changes in interest rates. number of shares in issue. “Fully diluted” (See also modified duration, convexity.) earnings per share takes account of the dynamic asset allocation (DAA) total number of shares allowing for any Any portfolio investment strategy where convertible securities. the proportion of the portfolio invested in a given asset class is varied over time. Company’s earnings per share divided by dynamic portfolio insurance (DPI) its current share price. This is the inverse of Form of portfolio insurance in which the the price/earnings (P/E) ratio. amount invested in the risky asset is EASDAQ variable. Most DPI approaches involve Independent, Brussels-based, pan- selling assets where returns have been European stock market set up in weak in order to ensure that the November 1996. It is set up along similar targeted level of return is achieved. lines to in the US and tends to (See portfolio insurance.) attract smaller and growth-oriented companies. Companies are allowed to list and trade in euros, sterling or US dollars.

EBITDA

Earnings before deduction of interest,

E taxes, depreciation and amortisation (an accounting term). EAFE ECB Europe, Australasia and Far East. Often See European . used to describe an overseas equity mandate for US investors. ECN See electronic network. early stage (private equity) Existing company requiring finance which has developed a prototype or service but still has limited revenue.

23 economic cycle efficient market Historic analysis of markets and Investment market where new information demonstrates that they is quickly reflected in the price of securities generally move in cycles. A typical cycle in the market. It is generally more difficult would start with a period of low economic for an investor to outperform in such activity and low confidence, depressing a market. consumer spending. After some time, in efficient portfolio anticipation of an economic and earnings Portfolio which appears on the efficient recovery, share prices start to rise. Interest frontier. There is no portfolio which has rates fall and stimulate economic activity, a greater expected return with the same and as the improves, company level of risk. earnings rise. This expanding economy eventually puts upward pressure on electronic communications network inflation and interest rates. Bond prices fall (ECN) and, as interest rates and inflation rise Electronic system that brings buyers and further, company earnings are hit and sellers together for the electronic share prices slump, leading to the start of execution of trades. It disseminates another cycle. information to interested parties about the orders entered into the network and allows economic indicators these orders to be executed. The ECN Statistics that give an indication of the thereby networks major brokerages (and state of an economy. Commonly used individual traders) so that they can trade indicators in investment analysis include directly between themselves without wholesale and retail inflation measures, having to go through a middleman. growth for various sectors of the economy, short- and long-term interest rates, the emerging market extent of unused manufacturing capacity Financial market in a developing or and retail sales. newly industrialising country. Such markets can deliver high returns because of the rapid pace of industrialisation, Person who analyses trends in economic but can be risky owing to low liquidity, indicators and attempts to forecast lack of reliable information and potential economic growth, likely trends in interest political instability. rates and inflation and the impact of such factors on financial markets. Debt issued by governments and corporations within developing Line of risk and reward that graphs all economies. Debt may be issued in the portfolios providing the greatest expected currency of the issuing country or, more return for a given level of risk or, commonly, in the currency of a major equivalently, the lowest risk for a given industrialised economy. expected return. 24 E Employee Retirement Income Security equalisation Act (1974) (ERISA) As income from a unit trust accrues Federal law in the US which governs between dividend distributions, it is added pension plans in the private sector and to the unit price. An investor purchasing specifies minimum levels of pension plan units will thus be paying for some of the participation, vesting, funding and many next dividend payment in the unit price, other fundamentals. Also introduced effectively turning capital into income stringent new standards of fiduciary (which is taxable). Unit trust managers responsibility on investment issues. state an equalisation factor with each distribution to indicate the proportion of enhanced indexation the total distribution that is not subject to Method of investment which attempts income tax. to outperform an index, but to a lesser extent than a traditional active manager. equities (See active management, passive Commonly used term for ordinary shares. management.) equitisation enterprise value (EV) Using derivatives to create an exposure to Market value measure of a company from equity market price movements, without the point of view of the aggregate of all the actually investing in stocks. The derivative company’s sources of funding, namely: positions combined with cash holdings debtholders, preferred shareholders, can be arranged so as to give the same minority shareholders and common equity returns as having the assets actually holders. Because EV is neutral with respect invested in stocks. The cash kept in a to , it is useful when portfolio for regular settlement of trades comparing companies with diverse capital can be equitised so that the portfolio is structures. (See EV/EBITDA.) fully exposed to the stock market. EPS premium See earnings per share. Extra return expected from investing in equities rather than a riskless asset to equal-weighted index compensate for the additional risk/ Index in which each component security is volatility associated with equities. given an equal value weighting. This results in the need for frequent equivalent yield () rebalancing, as the relative weightings are Time-weighted average of the initial yield disturbed whenever the value of one and reversionary yield. (See initial yield security moves relative to another. (See [real estate], reversionary yield [real capitalisation-weighted index.) estate].)

25 ERISA (ECB) See Employee Retirement Income Security Independent central bank responsible Act (1974). for setting and implementing and conducting foreign exchange ETF and reserve operations for the members of See exchange traded fund. the (European) Economic and Monetary ethical investment Union (EMU). Established in June 1998 Term given to an investment philosophy as an essential part of the adoption of a focusing on investing in companies single currency. according to non-economic criteria such European-style option as ethical or religious beliefs. (See socially Option which can only be exercised for responsible investment, green investing.) a short, specified period of time just prior euro (€) to its expiration, usually a single day. Single currency unit adopted by member Eurotop indices countries of the Economic and Monetary Indices covering the largest companies in Union (of the European Union; EMU) Europe and calculated by FTSE launched on 1 January 1999, with notes International. Variations are Eurotop and introduced on 1 January 2002. 100 (top 100 companies) and Eurotop 300 (top 300 companies). Bond that is issued by an international event risk syndicate or government and offered to Risk of a substantial change in the market investors in a number of countries at the price of a stock due to a particular event. same time. It is usually issued by a Often used in bond markets to describe non-European company for sale in Europe, the risk that the rating of a bond will drop but it does not have to be. Eurobonds are due to the taking on of additional debt or a issued outside the jurisdiction of any single recapitalisation by a company. country and are traded through banks rather than on stock exchanges. EV/EBITDA Method of valuing companies calculated euroland/eurozone by dividing a company’s enterprise value Group of countries which use the euro (market value of equity plus net debt of the as their common currency. company) by its earnings before interest, tax, depreciation and amortisation. This measure relates short term cash flow generation to market valuation. excess return Return of a security or portfolio in excess of its benchmark.

26 E F exchange rate exotic options Measure of the value of one country’s Generic term for complex financial currency in terms of another. Exchange engineering products created using a rates may be either floating (determined by combination of basic option contracts. the market forces of ) exit strategy (private equity) or fixed (values are artificially held at a Method by which venture capitalists certain rate or within a certain narrow band realise their original investment — usually of the value of a specified currency). by sale or flotation. exchange traded fund (ETF) expected return Fund that tracks an index, but can be Statistical measure of the average future traded like a stock. The most well-known return from an asset or portfolio. Often an ETF is the SPDR, which tracks the S&P 500. asset with a higher expected return will exchange traded options also have a higher of Options traded on a recognised exchange. return. (See also mean, standard deviation of return.) ex-ante Forward-looking measure or estimate. (See expiry date tracking error.) Last date on which an option can be exercised. ex-dividend Security where the purchaser is not ex-post entitled to receive the next coupon or Backward-looking measure using actual dividend payment. A security’s cum-or historical data. (See also tracking error.) ex-dividend status is dependent on the time it is purchased in the dividend/ coupon payment cycle. (See cum dividend.) exempt approved pension plan F Plan other than a personal pension approved under the Inland Revenue for certain tax advantages in relation to factor risk contributions and investment returns. Common trait that causes many securities to trade together. For example, country exercise price risk, sector risk, economic growth rate. Price at which a call option or put option may be exercised. Also known as the face value strike price. See nominal value.

27 fair value Financial Conduct Authority (FCA) Price deemed to accurately reflect the Independent body formed as one of price of a security, based on measurable the successors to the Financial Services valuation fundamentals. Considered to be Authority (FSA), focusing on the regulation an equitable valuation from the points of of conduct by the financial services view of both buyer and seller. Removes the industry in the UK. potential for a market participant making Financial Reporting Standard 17 risk-free profits from arbitrage. (FRS17) fallen angel UK accounting standard which sets out Highly rated investment grade bond that the accounting treatment of retirement falls (or is downgraded/re-rated) below benefits such as and medical investment grade. care during retirement. It has replaced SSAP24. FAS87 See Standard 87. Collective term for decisions made Federal funds rate by a government in relation to tax Interest rate at which the Federal Reserve and spending. It is a tool by which a (the US Central Bank) lends funds from government influences its economy. depository banks with excess reserves to Typically, spending will exceed income depository banks seeking additional (taxation) when a government is trying reserves overnight. Manipulation of the to stimulate the economy, and vice versa federal funds rate is the principal when it is trying to temper inflationary instrument for managing monetary policy growth. in the US. Also known as fed funds rate. Fitch Ratings fiduciary Independent rating agency that assesses Person or entity that acts for the benefit the creditworthiness of companies and and on behalf of another person or group their debt. The highest rating awarded is of persons. A fiduciary holds a legally AAA, and the lowest is D. Other well- enforceable position of trust. known agencies are Standard & Poor’s Financial Accounting Standard 87 and Moody’s. (FAS87) fixed interest asset US accounting standard which sets out the Asset where the timing and amount of accounting treatment of retirement future interest or coupons are specified benefits such as pensions. (and fixed) at the time of issue. See( also real asset.)

28 F flat yield curve forex Where short, medium and long maturity Common abbreviation for “foreign bonds in the market all have similar yields. exchange”. flight to quality forward contract Passage of funds from riskier to safer Contract to buy or sell an asset at an investments during periods of market agreed price at a specified date in the — for example, investors future. Forwards are similar to futures seeking government rather than corporate but are not exchange traded and need bonds. Can also refer to foreign investors not be standardised. withdrawing capital from a country during forward exchange rate times of political or currency instability. Exchange rate fixed today for the floating rate bond/ purchase or sale of a currency at a (FRN) specified future date. It is calculated on the Bond with a variable coupon rate, basis of a spot exchange rate and the periodically reset based on some interest rate differential between the two predetermined benchmark interest rate. relevant countries. Floating rate bonds are generally issued by forward interest rate banks or companies whose earnings are Interest rate fixed now on a loan that will closely tied to interest rate fluctuations as a occur at a specified future date. way of more closely matching interest payments to earnings. (FRA) Form of a forward contract between two floor parties to exchange an interest rate Interest rate contract where the purchaser differential on a notional principal amount receives from the seller, at the end of each at a given future date. Settlement is period prior to expiry of the contract, the through payment of the net differential difference between the strike interest rate only. A swap is a combination of FRAs. and current interest rate, should the interest rate fall below the strike. For forward rate option example, agreement to receive money for Contract giving the buyer the right, but each month during which LIBOR is less not the obligation, to exchange an interest than 4%. (See also cap.) rate differential on a notional principal amount at a given future date. flotation First issue of shares by a company on a FRN stock exchange. (See also initial public See floating rate bond/floating rate note. offering.)

29 free-standing additional voluntary FTSE 100 index contributions (FSAVC) FTSE international index of the top 100 Contributions paid by individuals into companies in the UK by market investment vehicles administered capitalisation. It is the most frequently independently of their occupational quoted measure of the UK market and pension scheme. Accrue benefits on a is also known as the “Footsie”. (The FTSE money purchase basis. (See also additional 250 measures the next 250 largest voluntary contributions.) companies. The FTSE 350 measures the top 350 companies). front-end load Initial payment, in the form of commission, FTSE All-Share Index paid to an intermediary or manager upon FTSE index for the main UK stock purchase of a security or unit in a pooled exchange. The index covers approximately fund. (See also no-load.) 800 companies. front office FTSE indices Dealing, research and activity of Family of indices compiled and promoted an investment management company. by FTSE International, covering most major (See also back office.) stock markets and regions worldwide. FTSE International Illegal practice in which a bank, aware of a Organisation that produces financial large order, executes a trade in the market market indices with the involvement prior to the release of the order to profit of the Faculty and Institute of . from an anticipated favourable price move. It is co-owned by the Financial Times and the . FRS17 See Financial Reporting Standard 17. fully funded Relates to a situation where a scheme’s FSA assets are sufficient to meet its liabilities See Financial Services Authority. (i.e. the scheme’s assets are sufficient to FSAVC meet its current and future benefit See free-standing additional voluntary obligations). contributions. (See also additional voluntary contributions.)

30 F fund manager funding risk Usually a member of an investment Possibility that a defined benefit plan fails management team who is responsible for to accrue sufficient assets to meet the ensuring that client portfolios are invested liabilities as and when they fall due (or in accordance with agreed mandates and more generally the likelihood that funding are kept in line with the asset mix specified deteriorates). by the investment team. The fund futures contract manager may also be responsible for client Forward contract that is traded on an reporting and relationship management. organised exchange and subject to the (See also investment manager.) guidelines and rules applied by that exchange. The features distinguishing Pooled fund which invests in other funds the futures market from the forwards rather than directly in underlying market are that the futures market uses a securities. Differs from a manager of clearing house facility, margin payments managers in that it is a combination of are required and the terms of futures funds, each of which is separately contracts are standardised. Establishes an available. A manager of managers obligation to the buyer and seller (or appoints underlying managers to invest subsequent holders of the contract) to separate portions of a single fund. (See also settle the contract through purchase or sale manager of managers.) of the underlying asset at the exercise date. Assessment of a company’s share value Market in which futures contracts are and potential for future cash flows, profit transacted. and dividends based on accounting, futures margin economic and business information When a futures contract is initiated, a (hence fundamental factors). (See also deposit (the initial margin) is paid to the technical analysis.) future exchange. This normally represents funding level a small percentage of the value of the For a pension fund, the ratio of the fund’s contract and helps in protecting the assets to its liabilities. Normally relates exchange against defaults. As the value of to defined benefit pension funds and used the contract changes, additional payments as a measure of the fund’s ability to meet may be requested (the variation margin). its future liabilities.

31 gilt (-edged) Bond issued by the UK government. The G payments on the gilt may be either fixed (fixed-interest gilt) or increase with inflation (index-linked gilt). So called GAAP because certificates used to be gilt-edged. Generally Accepted Accounting Principles. For pensions accounting in the UK, GAAP gilt repo will be FRS17 and in the US FAS87. Practice of selling gilts and simultaneously entering into an agreement to repurchase GARP them at a fixed time and price. A technique Growth at right (or reasonable) price; used to fund temporary cash shortfalls and a description of the approach some long gilt positions, or to gear portfolios by fund managers use to identify potential borrowing against gilts. Buying gilts share purchases. with a resale agreement is called a GDP reverse and is a means of lending cash See . on a collateralised basis. gearing gilt strip a. From an accounting point of view, the See STRIPS. amount of a company’s total borrowings GIPS™ divided by its share capital. High gearing See Global Investment Performance means a proportionately large amount Standards. of debt, which may be considered more risky for equity holders. Global Investment Performance b. In investment analysis, a highly geared Standards (GIPS™) company is one where small changes Set of minimum performance presentation in underlying conditions produce big standards for investment managers. swings in profits. Gearing can be Maintained by the CFA Institute and financial or operational, if, for example, a intended for global use. company has large fixed overheads. global tactical asset allocation general partner (private equity) Form of tactical asset allocation that Manager of the — employs derivatives, among other typically the investment manager. (See strategies, to take positive and negative limited partnership [private equity].) positions on equity and bond mandates and currencies that the manager’s research indicates are relatively attractively/unattractively valued.

32 G H GNP growth fund See gross national product. Fund that has the aim of achieving capital appreciation, typically an equity portfolio that has the aim of achieving Bond issued by a government. In the UK capital appreciation by investing in these are called gilts. growth stocks. governance growth investor/manager Describes the organisation, control and Investor who seeks out growth stocks. administration usually carried out by a body or committee. Stock that is expected to achieve above average earnings growth. Growth stocks Set of financial ratios pertaining to normally have a high P/E ratio relative to the derivative valuation, designated by the market as a whole, as investors anticipate Greek letters delta (∆), gamma (γ), rho (ρ), that earnings will increase in the future. theta (θ) and vega (ν). They are used to represent the factors that result in changes growth style in value of a derivative contract. Investment style focussing on growth stocks. green investing Investment which actively considers a company’s effect on the environment. greenback Colloquial term for the US dollar. H gross asset value (real estate) Sum total of property values held in portfolio (See also net asset value [real Difference between the quoted market estate].) value of an asset and the value attributed gross domestic product (GDP) to the asset for the purpose of holding it Total market value of finished goods as collateral. and services produced in a country in Hang Seng Index a given year. Principal share price index. gross national product (GNP) Gross domestic product with the addition of Generally refers to currencies of developed income from abroad by domestic residents, economies but is often restricted to refer minus income earned in the domestic to the major global currencies, that is, the markets accruing to foreigners abroad. US dollar, the euro and the yen. (See also soft currency.)

33 house view Fund that seeks to generate investment Formal opinion formed on an issue by an returns by using non-traditional investment organisation as a whole. strategies, utilising mechanisms such as hurdle rate short selling, leverage, , Minimum rate of return required before a arbitrage, and tools such options, futures, prerequisite profit is made or a performance swaps and forwards (derivatives in general). fee is paid. hedging Action taken to protect the value of a Describes extremely high rates of inflation. portfolio against a change in market Usually coincides with general economic prices, often by offsetting the exposure to collapse. a specific risk by entering a position in an investment with the exact opposite pay-off pattern. It is usually used to reduce or eliminate risk, although similar techniques can also be used to speculate in a market.

Hedge Funds Standards Board (HFSB) I Industry body responsible for creating and monitoring best practice standards for IAS19 hedge fund managers. It is an independent See International Accounting Standard 19. body, and compliance with the standards by hedge funds is voluntary. IE01 The change in present value of an asset or high yield bond liability for a 1 basis point change in the See junk bond. implied inflation curve used to value the asset or liability. high yield stocks Shares which have a higher than average IIMR dividend yield or those where a relatively See UK Society of Investment Professionals. high proportion of the total return is derived from dividend income. Typical illiquid examples of high yield stocks are utilities. Investment that cannot be quickly converted into cash at a predictable historic volatility price — for example, real estate and thinly Volatility as mathematically determined traded securities. from price fluctuations of the underlying asset over a past specified period of time. IMA (See also .) See investment management agreement.

34 H I IMC in-specie transfer See Investment Management Certificate. Direct transfer of a basket of stocks from one manager’s portfolio to another immunisation without disinvesting and reinvesting. Matching of assets and liabilities so that each is affected equally by changes in the in-the-money external environment. For example, a Indicates whether a traded option has pension plan may be at least partly positive intrinsic value. If current market protected from any change in the cost of prices make it beneficial to exercise an buying an annuity by purchasing a long option, the option has value and is dated bond. While a fall in interest rates therefore in the money. With call options it will increase the price of an annuity, this is where the exercise price is below the will be offset by a corresponding increase current price of the underlying security. in the value of the bond. With put options it is the reverse. (See also intrinsic value.) implemented consulting Combined service offered by consultants, income bond whereby trustee clients delegate a range Bond that promises to pay interest only of fiduciary functions to the consultants to when earned by the issuer. implement on behalf of the trust. income stock implementation shortfall See high yield stock. Quantitative measure of the cost of the indenture transition, which includes both direct and Written agreement between the issuer of a indirect costs. It compares the actual value bond and bondholders that specifies of the portfolio at the end of the transition maturity date, interest rate, convertibility process with the value that would have and any other options. resulted had the transition been implemented instantaneously and at no index cost at the outset. a. Measure updated regularly that gives a representation of the movement implied volatility in value of a particular market or a Volatility as calculated by determining the specified group of securities. variable in the relevant option pricing b. List of prices or other characteristics formula (e.g. Black-Scholes) based representing a particular group of goods on market option prices. (See also or services which gives an indication of historic volatility.) movements over time — for example, the IMRO Retail Prices Index, the Average Earnings Investment Management Regulatory Index and the Retail Sales Index. Organisation. c. To invest in line with the index weightings.

35 inflation hedge ratio See index-tracking fund. The inflation PV01 of assets divided by the inflation PV01 of liabilities. indexation a. Use of index funds. (See also passive management.) Exchange of two cash flows, one based on b. Adjustment of payments or values in line an agreed inflation rate for a period and with movements in a particular index of the other based on the actual inflation rate prices or earnings. for that period. Typically, the inflation basis will be LPI or RPI. index-linked gilt UK government stock with the interest payments and the final redemption Ratio of excess return to risk taken proceeds linked to the Retail Prices Index. (as measured by tracking error). Hence, Such stocks provide protection against a measure of risk-adjusted return. inflation whereas conventional gilts do not. initial margin index-tracking fund Returnable collateral that must be Investment fund which aims to match the deposited by a futures market participant returns on a particular market index. The when initiating an open position. It is also fund may hold all the stocks in the required of writers of options. particular index (known as replication) or, initial (IPO) more commonly, use a mathematical First public sale of a company’s equity model to select a sample that will perform resulting in a quoted stock price on a as closely as possible to the index (known securities exchange. as sampling). Also known as an index fund. initial yield (real estate) industry sector Annual rent divided by the value of Companies listed on stock exchanges the property. are usually categorised according to their principal area of activity, for example, inside information banks, building materials, electronics, Price-sensitive information that is not food producers, health care, leisure, oils, publicly available — information which pharmaceuticals and retailers. only employees or management of a company are likely to know. inflation Measure of the rate of increase in prices, insider trading for example, the movement over time in Illegally trading in shares when in the Retail Prices Index. (See also index.) possession of price-sensitive information that is not known to the market.

36 I Institute for Investment Management (IRR) and Research (IIMR) Constant rate of return that makes the See UK Society of Investment Professionals. present value of all future cash flows from an investment equal to its purchase price. institutional fund This is the calculation method usually used Assets managed on an organisation rather for assessing returns from private equity. than individual level. Types include pension plans, insurance funds, corporate International Accounting Standard 19 funds, charities and banks. (IAS19) Accounting standard (of the International institutional investors Accounting Standards Board) which sets Investment managers managing money out the accounting treatment of retirement on behalf of institutional and other benefits such as pensions. Currently third-party funds. adopted as standard in Europe. inter-bank rate International Swaps and Derivatives Rate at which banks bid for or offer funds Association (ISDA) to each other in a particular market. Trade organisation of participants in the interest market for over-the-counter derivatives. Return earned on funds which have been Responsible for creating the standardised loaned or invested (i.e. the amount a ISDA Master Agreement. borrower pays to a lender for the use of intrinsic value (of an option) his/her money). Difference between the strike price of a interest hedge ratio traded option and the market value of the The interest rate PV01 of assets divided by underlying security. (See also at-the- the interest rate PV01 of liabilities. money, in-the-money, time value.) interest rate collar investment Simultaneous purchase and sale of a cap Asset acquired for the purpose of and a floor with the aim of maintaining producing income and/or capital gains for interest rates within a defined range for a its owner. borrower or lender. The premium income investment advice from the sale of the floor reduces or offsets Advice about investment issues given the cost of buying the cap. formally by a suitably qualified person (as interest rate swap defined by the 1995 Pensions Act). The Exchange of two sets of cash flows, usually scope of advice might incorporate asset one based on a fixed interest rate and the allocation strategy, appointment of other on a floating interest rate. investment managers and performance measurement.

37 investment adviser investment grade See investment consultant. Bond rating of equal or greater than BBB (with S&P) or Baa3 (with Moody’s), investment analyst indicating low uncertainty as to the Individual who specialises in the analysis of issuer’s ability to meet the obligations companies and their performance. An undertaken in the bond. (See also analyst normally gathers information by low grade.) studying the information contained in company annual reports, researching the investment management agreement product markets in which a particular (IMA) company operates, visiting manufacturing Important legal document that defines the sites and meeting with key company relationship between an investor personnel. Analysts may also analyse and the investment manager. It usually markets and economies. incorporates guidelines and objectives. investment bank Investment Management Certificate Bank that offers a range of financial (IMC) services, usually including fund UK benchmark examination for individuals management and advisory work, such as engaged in discretionary or advisory takeover and merger assistance, as well as management of investments, overseen corporate finance, including the placing of by SIP. new share and bond issues, arrangement investment manager of loan or credit facilities, and stockbroking Organisation that invests assets on behalf services. of third parties for a fee. Can also refer to investment committee the individual responsible for day-to-day Appointed subgroup of a plan’s trustee management of the assets, although this board responsible for various aspects of individual is more often referred to as a the plan’s investments. fund manager or . investment constraints investment manager guidelines See constraints. Statements contained in an investment management agreement that restrict, investment consultant permit or prohibit a manager from Person or firm that is suitably qualified to certain investments when managing a give investment advice (as defined by the specific mandate. 1995 Pensions Act) to trustees or other responsible bodies.

38 I investment objectives investment strategy Results desired by an investor or fund. Investor’s long-term distribution of assets They may be expressed as a specific among various asset classes, taking into performance target or a general statement consideration, for example, goals of the of intent. trustee group, attitude to risk and timescale, etc. investment performance Total return earned on a portfolio of assets investment structure over a particular period. Way in which fund managers are employed to invest assets, in particular the type of investment performance measurement investment managers employed Calculation and analysis of investment (specialists, multi-asset, active or passive) performance usually including a review and the number of managers employed. of sector strategy and stock selection. Also called investment manager structure. Returns may be compared with a benchmark fund or index or with the investment team actual returns achieved by other Group of individuals in an investment managers or portfolios. (See also WM management organisation who are Performance Services.) responsible for the construction of portfolios and the performance of funds investment philosophy under management. The team may Set of principles or systems used by include some or all of the following: a investors to govern the way they manage strategy specialist, , fund portfolios. managers, investment analysts, equity and investment risk bond dealers, currency specialists, a. Risk that an asset will not deliver derivative specialists, property specialists the expected returns (or meet the and money dealers. objectives) for which it is held. b. Chance that a permanent loss will be Closed-end fund quoted on a stock sustained on an investment through exchange that holds/manages shares and company failure, default on loans, investments in other companies. The or other factors. closed-end nature means that the price of c. Volatility in the value of a security or the fund fluctuates in line with supply and market, usually measured as the demand as well as in line with the value of standard deviation of returns over a the underlying investments. Thus, given period. investment trusts may trade at a premium or discount (usually the latter) to the value of the underlying investments.

39 investment policy implementation ISIN document (IPID) International Securities Identification Document which serves as an adjunct to Numbering system advocated by the G30. the SIP, setting out greater detail on, for The ISIN code is a unique 12-digit code example, the funds in which a scheme is given to a security and is used worldwide. invested, its strategic benchmark issued share capital allocations and tolerance ranges for Portion of a company’s authorised share rebalancing around the central benchmark. capital that has been issued by the IPO company (i.e. is publicly held). See . issuing house IRR Financial , often merchant See internal rate of return. banks, that act as intermediaries between companies seeking capital and the IRS investors prepared to supply it. Internal Revenue Service. It is a branch of the US Department of Treasury and is the country’s tax collection agency.

ISDA See International Swaps and Derivatives Association. J ISDA Master Agreement J-curve effect (private equity) Bilateral derivative trading agreement Illustrative payoff profile for private equity containing general terms and conditions investments, in terms of which short-term (such as provisions relating to payment losses are expected to be offset by greater netting, basic covenants, events of default profits in the longer term. and termination). The Master Agreement does not, by itself, include details of any JGB specific derivatives transactions the parties Japanese government bond. may enter into. These will be covered in an adjoining Schedule and in the Credit junk bond Company bond that has been given a low Support Deed/Annex. (See also Credit Support Deed.) rating/sub-investment grade by credit rating agencies. Junk bonds offer higher expected returns to compensate for the increased risk. (See also distressed debt.)

40 I J large cap stock K Stock with a market capitalisation of L K among the largest within a market — for example, the capitalisation of one of the top 100 companies in the UK as represented by the FTSE 100 index. In the School of economic thought (named after US, it is defined as a stock with a market ) which advocates capitalisation of over US$5 billion. (See also government intervention and spending to small cap stock, mid cap stock.) manage the economy, promote growth and control prices. last look Practice of allowing one bank the kurtosis opportunity to match the pricing Measure of the relative peakedness arrangements available from other banks or flatness of a statistical distribution in the market, as a condition for their compared to the normal distribution (a services being employed. statistical distribution often used as a fairly good approximation of reality because it is league table mathematically easy to manipulate). A Ranking table of the comparative normal distribution has kurtosis of 3. performance of investment managers or Higher kurtosis indicates a relatively funds in, for example, the Mercer MPA, peaked distribution and a higher Russell/Mellon or WM Company surveys. frequency of observations in the tails of the Also called peer group analysis. (See also distribution. Lower kurtosis indicates a Mercer Manager Performance Analytics.) relatively flat distribution. Equity market lease returns generally have a higher kurtosis Written agreement under which a property than the normal distribution — in other owner allows a tenant to use the property words, they are “fat-tailed”. for a specified rent and period of time.

leasehold

Right to hold or use property for a fixed

period of time at a given price, without

transfer of ownership, on the basis of a

L lease contract. leverage laissez faire Use of borrowed money to over-invest a View that markets are efficient and portfolio which magnifies both gains and government intervention in the economy losses. This may be achieved by derivative should be minimised. instruments. Also refers to the debt/equity ratio in a company’s balance sheet.

41 LIBOR Use of borrowed money, usually from London Interbank Offered Rate. The private equity investors, to purchase a interest rate at which London-based banks company. A leveraged management are prepared to lend money to other buyout (LMBO) is the purchase of a banks, in a specified currency and for a company, using leverage, by the specified period. See( also LIBID.) company’s management. (See also LIBOR-LIBID spread private equity.) Difference between the interest rates at Local Government Pension Scheme which banks will lend to and borrow from (LGPS) one another, typically at least 12.5 bps but Public sector pension scheme for sometimes wider (especially for longer individuals working in local government, periods). This spread is important in swap local authorities and other public services. dealing since cash deposited by companies seldom earns more than LIBID liabilities and the floating side of most swaps Financial obligations — for example, requires payment of LIBOR. money owed to banks or future pension payments — that must be met to satisfy life company fund the contractual terms of the obligation. Pooled fund that is operated by a life Liabilities may be time-based (i.e. payable assurance company. Such funds are similar at a specific time) or contingent upon the to unit trusts except that investors own a occurrence of a future event (e.g. life assurance policy rather than units. retirement, death). (See also asset/liability lifestyle/lifecycle modelling.) Adjustment of a member’s defined liability-driven investing (LDI) contribution plan asset allocation in line Process whereby an investment strategy is with set measures, for example, years to set with explicit reference to a specific set retirement. The purpose is to reduce risk of of liabilities. loss of pension-buying power as the member approaches retirement. LIBID London Interbank Bid Rate. The interest LIFFE rate at which London based banks are See London International Financial Futures prepared to borrow money from other and Options Exchange. banks, in a specified currency and for a limited partnership (private equity) specified period. See( also LIBOR.) Structure typically used for private equity funds. Investors are limited partners. (See also general partner.)

42 L limited price indexation (LPI) listing Method commonly used to increase Acceptance of a security for trading on a pensions in payment. The increase is registered exchange. based on the RPI with an annual cap of listing particulars usually 5% or 2.5% per annum, and Detailed information a company is pensions are not reduced if the RPI falls required to give about itself when it applies over the year. to be listed on a stock exchange. It is liquid market published in the form of a prospectus. Market with a high degree of liquidity, loan stock often resulting from a large number of Another name for a bond, normally used to buyers and sellers. There can be large denote loans issued by non government variations in the liquidity of different equity bodies such as companies. markets, with the most liquid being the large international markets — New York, loan-to-value (real estate) Tokyo and London. Debt expressed as a percentage of property value. The greater the loan-to-value, the liquidity greater the amount of gearing employed. a. Degree to which an asset or portfolio is easily marketable or turned into cash. London Interbank Offered Rate The most liquid equity stocks are those See LIBOR. of the large blue chip companies quoted on the large international markets. London International Financial Futures Liquidity can be measured by and Options Exchange (LIFFE) considering trading volume relative to a Largest UK futures and options market. company’s issued share capital. long bias b. Proportion of liquid assets such as cash Long/short fund with a net long position and short-term instruments in a and therefore positive exposure to an portfolio. increase in the underlying market. liquidity premium long bond Additional return required to compensate Bond that has more than 10 years to run an investor for an investment with lower to maturity. liquidity than cash. Also known as premium. long position State of actually owning a security, listed (stock) contract or commodity. (See also short Stock traded on a registered stock position.) exchange — for instance, the NYSE or the LSE.

43 long/short fund Hedge fund comprising a mixture of long and short positions in the same asset class M or market. The net market exposure could be long or short (see market-neutral fund). A subgroup of long/short funds, also M&A known as extension strategies and 120/20 See . or 130/30 funds, where the fund short managed fund sells — for example, 20% of the total value Pooled fund that invests across a wide of the fund — and uses the proceeds to range of asset classes. increase the fund’s long position. management buy-in (MBI) low grade Purchase of a controlling interest of a Bond rating of lower than BBB, indicating company by an outside investor where some uncertainty as to the issuer’s ability either new management is implemented to meet the bond’s obligations. (See also or existing management is retained. investment grade.) management buyout (MBO) LPI Repurchasing of all, or the majority of, a See limited price indexation. company’s outstanding shares by a firm’s LSE own management. London Stock Exchange. management charges lump sum Fees levied by investment managers, Payment of a one-off amount as opposed usually in the form of a percentage of to a series of periodic payments. Most (typically either pension funds allow members to take a on a fixed scale or on a sliding scale that lump sum on retirement in return for a decreases with fund size). The charge is reduced pension (a process sometimes based on the fund managers’ services and called commutation). usually also includes fund administration costs. In addition, in the case of some pooled funds, a charge may be made on new contributions. (See also performance- related fee.)

44 L M manager monitoring market Quantitative review of an investment Public place where buyers and sellers manager’s performance against his or make transactions, directly or via her benchmark and within any specified intermediaries. guidelines (e.g. risk control), and a market breadth qualitative review of the prospects for Proportion of the total market that is taking future performance from the manager. part in the market’s up or down move. manager of managers market capitalisation Single fund manager who appoints a series Total market value of securities issued by a of underlying managers in each asset company, industry, sector or market(s). It is class. Often these underlying managers calculated by multiplying the market price are specialists targeting higher per share by the number of shares issued. outperformance. The managers’ styles should complement each other within market cycle each asset class to avoid style biases. The See economic cycle. manager of managers is responsible for monitoring, hiring and firing the market index underlying managers. See index. manager structure market indicators Combination of investment managers Technical measurements used by market to run a specified pool of assets (e.g. a analysts to forecast the market’s direction, pension plan’s assets). (See also core/ such as the volume of trading or the satellite, specialist management.) direction of interest rates. mandate market inefficiency Description of the fund management Condition in which current security requirements that an investor demands prices do not reflect all the publicly from a manager — for example, high-risk available information about a security, global equity management. May include such as when some investors receive performance targets set by reference to information before others, or when some a benchmark. investors do not effectively analyse the available information. margin a. Procedure allowing investors to borrow against their existing holdings to buy Organisation that undertakes to buy and/ more securities. or sell certain securities whenever demand b. Collateral required as security against or supply exists at their quoted prices. open positions in derivative markets. Market makers quote firm buying and selling prices for the shares in which they wish to deal.

45 market-neutral fund marketability Long/short fund with no net bias to the Measure of the ease with which a security underlying market. may be bought or sold. If there is an active marketplace for a security, it has good market price marketability. Marketability is similar to Security’s last reported sale price (if on an liquidity, except that liquidity implies that exchange) or its current buying and selling the value of the security is preserved, prices (if over the counter) — that is, the whereas marketability simply indicates price as determined dynamically by buyers that the security can be bought and sold and sellers in an . Also known easily. However, low marketability may as market value. lead to a widening of the spread between buying and selling processes. Risk, representing the of an mark-to-market adverse change in value, which is common Recording of the market price or value of a to an entire class of assets or liabilities. It is security, portfolio or account on a regular the level of risk in the market that cannot basis, to calculate profits and losses or to be eliminated by diversification. Also confirm that margin requirements are known as . (See also being met. non-diversifiable risk.) marketweight market timer Specific rating within a three-part credit Investor who believes that he/she can rating system which indicates whether a predict the timing of changes in future fixed income security should be bought market directions and invests based on (overweight), sold (underweight) or held this belief. (marketweight). (See also overweight, market value underweight.) See market price. maturity date market weight Date upon which the last payment is made When the allocations to securities in a under a fixed interest stock or bond. portfolio are the same as the allocations maturity value to securities in a representative sample of Amount that will be received at the time a the market. security is redeemed at its maturity. MBI See management buy-in. MBO See management buyout.

46 M mean Mercer Manager Performance Average amount or value. Analytics™ Tool developed by Mercer providing theory comprehensive analysis of investment Theory that assumes financial ratios and performance and risk against peer asset class returns have long-term groups, industry medians or relevant equilibria (means), and that when there is a index benchmarks. deviation from these equilibria, reversion to the equilibrium (mean) can be expected. Mercer MPA™ See Mercer Manager Performance median Analytics. Value of the middle figure in a distribution of values that have been ranked according mergers and acquisitions to size. For example, a median Combining two companies to create one performance among a universe of five larger company that is expected to be managers would be the third-ranked more valuable than the individual manager. A median return is not the same companies on their own. In an acquisition, as the mean and may be above or below it one company is a clear buyer aiming to depending on the distribution of returns. completely take over a “target” company. The target company ceases to exist whilst Mellon Analytical Services the buyer company’s shares continue to One of the main service providers in the e traded. In a merger, two companies UK that independently analyses the (usually of similar size) cease to exist as performance of pension funds and their individual companies (with separate stock investment managers. Owned by Mellon on the market) and agree to operate as a Financial Corporation. Formerly known as completely new company with new stock Russell/Mellon and Combined Actuarial being issued. Performance Services (CAPS). mezzanine (private equity) member profiling (defined contribution) Company whose flotation on a quoted Analysis of the investment decisions market is imminent. made by members of a defined contribution pension scheme. Member mezzanine debt profiling enables trustees to determine the Hybrid between debt and equity. Often, investment options that are being selected for example, low-priority debt packaged by various scheme members and how together with an equity . these options change with respect to MFR factors like age, gender, appetite for risk See minimum funding requirement. and salary. Based on the results of the member profiling, trustees are able to improve the investment fund range available to the members of the scheme.

47 mid cap stock (MPT) Stock with a middle-ranking market Blanket name for the quantitative capitalisation within a market — for analysis of assets and optimisation of their example, in the UK a mid cap stock is collective composition, based upon their normally considered to be one placed in expected return, expected risk (standard the FTSE Mid 250 index. In the US, it is deviation) and correlations. According to defined as a stock with a market MPT, investors should only invest in capitalisation of between US$1 billion and portfolios (constituting of the previously US$5 billion. (See also small cap stock, analysed assets) which generate the large cap stock.) highest return at any given level of risk. mid price modified duration Average of the bid and offer price of Level of price sensitivity resulting from a security. (See also ask price, bid price, small changes in the of a offer price.) bond. It is measured as the percentage change in the bond’s price for a small MiFID change in the yield. (See also duration.) Markets in Financial Instruments Directive (November 2007). Aims to introduce a MOM and regulatory regime for See manager of managers. investment services across the 30 member states of the European Economic Area. Its Extent to which stock market values are three major objectives are: (1) creating a supported by a strong level of trading unified market in investment services for activity and investor interest. Also refers the EU; (2) responding to changes in EU to an investment style of purchasing security markets; and (3) protecting stocks that have recently exhibited strong investors against fraud and anti- price growth. competitive behaviour. monetary policy migration risk Management of the economy by use of Risk that a bond will be downgraded to a interest rates and . Monetary lower rating by one of the independent policy can be used to reflate or deflate the ratings agencies, reflecting its likelihood of economy. Interest rates used to be set in default. As a bond migrates downward its the UK by the Chancellor of the Exchequer. price falls. In June 1997, however, control over minimum funding requirement (MFR) setting interest rates was passed to the Funding regime for UK-defined benefit Bank of England Monetary Policy pension schemes introduced in 1997 and Committee (MPC). phased out from September 2005.

48 M money at call Debt which must be paid upon demand. Indication of market trends obtained by averaging prices/indices over continuously moving periods, for example, Market for short-term loans and deposits. over 30 or 90 days. money purchase MSCI See defined contribution. See Capital International money-weighted rate of return indices. Calculation of the actual return achieved multi-asset management over a period, taking into account actual Where an investment manager’s mandate cash flow experienced by an investor. covers a number of different asset classes Since the calculation does not adjust — for example, UK equities, US equities, UK for the timing of cash flows, it is not and overseas fixed income, and cash — and suitable for comparative analysis of is measured against either a specific or investment manager’s performance, since non-specific benchmark. See( also balanced external cash flows are usually beyond the management, specialist management.) manager’s control. Also called internal rate of return. (See also time-weighted rate multi-strategy fund of return.) Usually a fund offered by a single investment manager investing in a range of Moody’s in-house sources of both market risks Independent rating agency which (beta) and active management techniques. assesses the creditworthiness of Generally targeted at absolute returns. companies and their debt. The highest rating awarded is AAA, and the lowest is D. Other well known agencies are US name for an open-ended pooled fund Standard & Poor’s and Fitch Ratings. operated by an investment manager. Morgan Stanley Capital International Myners Code (MSCI) indices Set of voluntary principles for UK pension Family of indices covering most main stock funds encompassing governance, markets and regions worldwide. investment decision-making and reporting, arising from the Myners Review mortgage-backed securities (MBS) and revised from time to time. (See also Investment instrument that represents Myners Review.) ownership of an interest in a group of mortgages. Principal and interest from the individual mortgages are used to pay principal and interest on the MBS.

49 Myners Review narrow market Review carried out by Paul Myners on Market with little trading activity. Because behalf of the UK government. The review, of the low volume of trading it displays high published in March 2001, investigated the volatility, high spreads and low liquidity. challenges facing institutional investment NASDAQ decision making and recommended that National Association of Securities Dealers pension fund trustees follow a set of Automated Quotations System. US stock principles known as the Myners Code. exchange that has a particular emphasis (See also Myners Code.) on developing and technology companies. The NASDAQ Composite Index is an index covering all stocks in the NASDAQ market.

National Trust

National pension scheme set up to help

N people on low to moderate incomes with no access to proper employment NAFTA pension schemes save for an income in See North American Agreement. retirement. (See also Personal Accounts Delivery Authority.) Where the writer of a call option (the national income (NI) “seller”) does not own the underlying Annual income earned by a country for security (this is also known as an its production of goods and services. “uncovered” position). This is a bearish NAV position because the writer expects the See net asset value. stock price to fall. By not holding the underlying security, the writer is negative convexity essentially exposed to an unlimited loss. When a bond’s price rises less for a downward move in yield than its price declines for an equal upward move in yield. Where the writer of a put option (the “seller”) does not own the corresponding negative yield curve short position in the underlying security Described as being negative (or inverted) (this is also known as an ”uncovered” when the yields on short-term bonds are position). This is a bullish position because higher than the yields on long-term bonds. the writer expects the stock price to rise. This can imply that interest rates are By not holding the underlying security, the expected to decline, or that there is excess writer is essentially exposed to a loss equal demand for long-term bonds. to the value of the options’ strike price.

50 M N NEST net present value (NPV) See National Employment Savings Trust. Present value of expected future cash flows minus any initial and ongoing net asset value (NAV) investment costs. Often used in capital Total market value of assets minus its total budgeting to determine whether or not liabilities. The unit price of an open-ended to make an investment (if negative, the pooled fund is calculated with reference to investment should not be made). the NAV of the fund (the NAV of a unit being the NAV of the fund divided by the total New York Stock Exchange (NYSE) number of units in the fund). The market Largest stock exchange in the US. price of shares in a closed-end pooled fund Nikkei may stand at either a discount or premium ’s headline index. It to NAV. (See also closed-end fund.) covers only a relatively small number of net asset value (real estate) stocks (225). Gross asset value less the value of debt nil cost (specific to derivatives) (leverage) in a property fund. (See also Simultaneous purchase and sale of options gross asset value [real estate].) on the same underlying security for the net domestic product same period with the same premium but at Gross domestic product after deductions different strike prices. for the depreciation of a country’s no-load capital goods. Without any sales charge. (See also net income front-end load.) Company’s gross sales revenues minus NOI taxes, interest, depreciation and See net operating income. other expenses. nominal interest rate net operating income (NOI) Interest rate in monetary terms, Gross sales revenue minus operating unadjusted for inflation. See( also real expenses. There is no deduction for taxes interest rate.) or interest. nominal rate of return net position Rate of return expressed only in monetary Where a fund can short sell securities, the terms — that is, not adjusted for inflation. net position refers to the level of a fund’s exposure to market risk. For a long/short equity fund, if a fund is 100% long and 30% short, then the net position is 70% (also known as net exposure). Traditional investment funds are 100% long.

51 nominal spread non-rated bond Difference between the redemption yield Bond which has not been rated by a large on a specific bond, and the redemption rating agency (e.g. Moody’s or S&P) and yield of a gilt of the same maturity. Not therefore carries the risk of potentially considered a good measure of differential being poor quality. pricing, as it does not take into account non-systematic risk how changes in the shape of the overall Risk attributable to an individual company, yield curve may impact on relative market pertaining to factors not associated with values. (See also option-adjusted spread, the sector or broader market. The impact of Z-spread.) non-systematic risk factors can be reduced nominal value by the diversification of a portfolio. Of a bond, its par or face value on which normal distribution interest and capital repayments are based. The most common type of distribution Of an equity, the book value at which the for a variable whereby the probability shares were issued. distribution plots all of its values in a nominee symmetrical fashion and most of the results Person or company that is registered as are situated around the probability’s mean. the owner of a security. The assets of Often associated with the term bell curve, segregated pension plans are usually held this terminology is an extension of the fact in nominee accounts which, for that the graph used to depict a normal convenience, are registered in the name of distribution consists of a bell-shaped line. the investment management company. normal yield curve However, the pension plan remains the Described as being normal when the yields beneficial owner of the securities. on short-term debt are lower than the non-diversifiable risk yields on long-term debt. Also known as a Risk inherent in a particular market. Owning positive yield curve. a greater number of securities from that North American Free market will not reduce (diversify away) this (NAFTA) risk. Also known as systematic risk. Agreement promoting free trade between non-interest bearing note the United States, , and Mexico. Type of zero coupon bond. note non-private Short-term debt instrument, usually with a Category of investor (as required by the maturity of five years or less. FSA) given limited protections under the conduct of business rule. (See also private customer.)

52 N O notional amount Official Journal of the European Union Notional amount for a derivative contract Official publication in which all tenders is the quantity/value of the underlying above a defined monetary value for securities to which the contract applies. services issued by public sector organisations within the European novation Union must be advertised. This includes Substitution of a new entity for one of the tenders for investment managers to take parties to an agreement (e.g. a swap on mandates issued by Local Government agreement), with the consent of each of Pension Schemes. the parties involved. offshore company NPV Company incorporated in a country other See net present value. than that in which its main operations take NYSE place, usually where there is little See New York Stock Exchange. government control and/or low taxes. OJEU See Official Journal of the European Union.

OPEC

See Organization of Petroleum Exporting

O Countries. open position OECD Normally used in the context of exchange- See Organisation for Economic Co- traded futures and options. It denotes a operation and Development. position that is exposed to movements in OEIC the price of the futures and options. See open-ended investment company. open-ended funds offer price Collective investment schemes in which Price at which a security or a unit in a the number of units in the fund varies from pooled fund can be purchased — usually day to day according to the number of higher than the bid price. (See also ask investors wishing to buy or sell holdings in price, bid price, mid price.) the fund. The price of units is set by the manager of the scheme by reference to the net asset value of the fund. (See also closed-ended fund, net asset value.)

53 open-ended investment company option-adjusted spread (OAS) (OEIC) Fixed number of basis points that would Type of open-ended pooled fund vehicle need to be added to the gilt yield curve at (see open-ended funds), legally set up as a all durations to equate the market price of company and similar to a unit trust in a bond with the present value of the practical operation. bond’s future payments, taking into account any options inherent in the bond. opening price Bond options include the right (of the Price at which a security commences borrower) to repay capital prior to the trading at the opening of a trading day. bond’s maturity date, or the right (of the operating cash flow lender) to demand early repayment of Value of cash moving through an capital. Using the OAS rather than the organisation as a result of its operational nominal spread allows for direct (rather than financial) activities. comparison between option-free bonds and those that have put or call features. (See also Z-spread, nominal spread.) Risk arising from failed processes in carrying out a company’s business functions. option writer Person who “sells” an option. The writer has the obligation to buy/sell the Cost of missing out on the best choice underlying security at the request of the when making an investment decision. For option buyer. example, a large fund may be too big to purchase an attractive share without ordinary share moving the market price against itself, and Share in the ownership of a company would miss out on this opportunity that gives the holder the right to receive compared with a smaller fund that would distributed profits and to vote at general not move the price. meetings of the company. An ordinary ranks behind all other optimisation creditors/investors if the company is Creation of a portfolio which will give the wound up. highest expected total return for a given set of forecasts and estimated risks. organic growth (See also efficient frontier, modern Where a company grows its existing portfolio theory.) business as opposed to growth through mergers or acquisitions. option Right, but not obligation, to buy or sell a security at an agreed price within an agreed time period. (See also call option, put option.)

54 O Organisation for Economic Co- outperformance operation and Development (OECD) Used to refer to the performance of a International Paris-based organisation portfolio relative to its benchmark — a consisting of developed European portfolio is said to outperform if its return countries as well as the USA, Canada and is greater than that of its benchmark. . Its mandate is to promote Underperformance is defined similarly. economic and social welfare in each of its over the counter (OTC) member states. Any market which does not operate Organization of Petroleum Exporting through a recognised exchange — for Countries (OPEC) example, , any Group of countries that collaborate in non-standard option contract. order to manage their exportation of crude overlay manager oil to the rest of the world. Investment manager engaged to generate OTC additional returns or to reduce risk See over the counter. through the management of a derivative portfolio which does not impact on the out-of-market risk underlying assets held. (See also currency Risk that a portfolio misses out on the overlay, protection overlay, tactical asset returns from a particular market because it allocation overlay.) is not invested in the market at the time. Out-of-market risk potentially arises during Overnight Index Swap (OIS) transitions when cash from selling assets is An interest rate swap involving the not immediately available for reinvestment. overnight rate being exchanged for a fixed interest rate. Generally short-term, the out-of-the-money interest of the overnight rate portion of the Option that has no intrinsic value. That is, swap is compounded and paid at reset an option which it would not be dates, with the fixed leg being accounted worthwhile to exercise immediately — for for in the swap’s value to each party. example, a call option with an exercise price above the current underlying share overvalued price, or a put option with an exercise price Security that a fund manager perceives to below the current underlying share price. be worth less than its market price, based on some other valuation criteria.

55 overweight par value a. Exposure to a specific asset (or asset See nominal value. class) which is higher than the proportion passive investor it represents in the market index or Investor who does not get closely involved benchmark against which the portfolio is with investee companies. Normally invests measured. Investment managers may as a member of a syndicated deal or via a take overweight positions in shares or pooled fund. sectors they expect to outperform in order to add value to the portfolio. passive management b. Specific rating within a three-part credit Portfolio which aims to replicate a rating system which indicates whether a particular market index or benchmark fixed income security should be bought fund and does not attempt to actively (overweight), sold (underweight) or manage the portfolio. (See also active held (marketweight). (See also management, indexation.) marketweight, underweight.) peer group analysis See league table.

pension Regular, periodic payment to an individual, usually following cessation of P employment. This benefit will often be defined benefit or defined contribution in P&L nature. (See also defined benefit, See profit and loss statement. defined contribution.) Pacific Rim Pension Protection Fund (PPF) Far Eastern countries and markets Independent body set up by the UK bordering the Pacific area. government in 2005 with the aim of providing financial assistance to the PADA members of defined benefit pension See Personal Accounts Delivery Authority. schemes whose scheme sponsor becomes Pan-European fund insolvent. The PPF is funded by a levy Vehicle that invests across all European imposed on all defined benefit pension countries including the UK. schemes. (See also defined benefit, scheme sponsor.) parity (convertible bonds) State in which the value of the equity (or other underlying security) is equivalent to the value of the bond on conversion.

56 O P Pensions Act 1995 performance attribution Major piece of legislation that was Process which assigns over- or introduced with effect from April 1997. The underperformance to the different steps Act required trustees for the first time to taken in the investment management produce and maintain a statement of process, such as asset allocation, stock investment principles (SIP) and introduced selection, currency management, etc. the minimum funding requirement (MFR). Used as a means to show where value has been added/lost. Pensions Act 2004 Major piece of legislation following the performance measurement Pensions Act 1995. Introduced a new Calculation of a fund’s historic return on its statutory funding regime to replace the investments. This can be performed on minimum funding requirement. Under total assets or on individual asset classes. this, pension funds are required to For the purposes of analysing a manager’s produce a statement of funding principles performance relative to a benchmark, setting out how they intend to achieve/ performance is calculated on a time- maintain full funding. Also formally weighted rate of return basis which is established the Pension Protection Fund unaffected by the size and incidence of (PPF). (See also Pension Protection Fund.) external cash flows (which are outside the manager’s control). P/E ratio (price earnings ratio) Commonly used indicator of the value of a performance-related fee stock, calculated as a company’s current Investment management fee determined share price divided by its earnings per by the degree of overperformance relative share. A high P/E ratio may be justified to an agreed benchmark. because a company is expected to increase permitted investments its earnings per share or it may indicate Investments detailed in an investment simply that the company is expensive. management agreement in which a percentile manager may invest. Relative ranking (in hundredths) of a particular portfolio (or manager) in a Bond that is issued with no redemption or league table of returns. For example, a maturity date. The coupons on a perpetual percentile ranking of 15 indicates that 14% bond are paid indefinitely. of portfolios performed better and 85% produced a lower return. perpetuity Stream of cash flows that theoretically will last forever.

57 Personal Accounts Delivery Authority pooled fund (PADA) Vehicle in which a number of investors Public organisation responsible for setting (including pension schemes) pool their up and managing a national trust-based assets so that they can be managed on a pension scheme for low to moderate collective basis. This usually suits small to income earners. (See also National medium-size investors wishing to invest in Employment Savings Trust.) a broad spread of investments or larger investors wishing to gain exposure to a PFI specialised sector. Shares in a pooled See private finance initiative. fund are denominated in units that are plan sponsor repriced regularly to reflect changes in Employer that sets up and funds a the underlying assets. This allows investors pension plan for its employees. Also to value their holdings and provides a called scheme sponsor. basis upon which transactions in units can take place. Unit trusts are examples of plain vanilla pooled funds. Describes financial instruments, especially bonds and derivatives, in their most basic portable alpha form or with standard features. Opposite See alpha transfer. of exotic. portfolio Block of assets generally managed under Fraudulent investment scheme which the same mandate. provides returns to investors either by using portfolio insurance the funds already paid into the scheme by Any one of several techniques used investors or by using the funds paid in by to change systematically an investment subsequent investors. The returns provided portfolio’s market exposure in response to investors in a Ponzi scheme are usually to prior market movements, with the abnormally high or consistent. A Ponzi objective of avoiding large losses and scheme usually collapses since the scheme securing as much participation as possible makes no actual investments and requires in any favourable market movements. continuous inflows of new capital to ensure These techniques often feature a principal that the money going into the scheme guarantee. (See also principal guarantee.) exceeds the money being paid out of the scheme as investment returns. In 2008, a portfolio manager Ponzi scheme operated by Bernard See fund manager. Madoff for several years collapsed. As a PPF result, Madoff was responsible for the See Pension Protection Fund. largest financial fraud to be committed (allegedly) by a single individual.

58 P pre-hedging present value Practice of a bank assembling a position Value in today’s terms of future cash over a period of time prior to entering into flows discounted at some appropriate a swap contract — this reduces the bank’s rate of interest. risk of hedging the swap position and is price earnings ratio only legal when authorised by See P/E ratio. the client. price-to-book ratio share Comparison of a security’s market value Type of share which gives the holder an with its book value, calculated by dividing entitlement to a fixed rate of dividend that the current closing price of a security by is paid before any dividends are paid to the latest published book value per share. ordinary shareholders. In the event of a company wind-up, preference shareholders rank ahead of ordinary Market in which securities are sold at the shareholders as creditors. time they are first issued. See( also .) premium a. For securities selling above par, the prime difference between the price of a Describes a property investment that is security and par. highly regarded in terms of location, age b. Amount that must sometimes be paid and condition, quality of tenant, size, and above par in order to call an issue — that lease structure. is, a call premium. c. Occasionally used and interchangeable prime broker with margin or spread when the latter Agent, usually an investment bank, two refer to a percentage above a given offering a suite of services including amount or rate. , cash management and execution of leverage trades. The prepayment risk services of a prime broker are most Risk which affects investors in CDOs and often used by hedge fund investors in MBSs that the borrowers/writers of the the interests of managing absolute underlying debt may choose to repay return investments. the loan early if interest rates fall, under conditions where investors are unable prime rate to reinvest the proceeds to achieve the Minimum interest rate in the US that redemption yield targeted at outset. commercial banks will charge borrowers. (See also base rate.)

59 principal profit and loss statement Capital element of a bond that is Summary of a company’s revenues and normally repaid at par value (usually 100) expenses over a specific period, which at the end of the term of the bond. shows whether the company has made (See also nominal value.) a profit or a loss. Also known as an income statement. principal guarantee Feature of certain portfolio insurance program trading products, usually achieved by investing Computerised trading used primarily by part of the principal amount in a zero institutional investors, typically for large coupon bond that will eventually return volume trades, where orders from the the amount invested over the agreed trader’s computer are entered directly period of the investment. (See also into the market’s computer system and cushion, portfolio insurance.) executed automatically. private customer property unit trust Category of investor (as required by the Unit trust that invests in commercial FSA), typically small companies/trusts, properties on behalf of third parties, which, as one of the more vulnerable usually pension schemes and charities. investor categories, are given significant prospectus protection under the conduct of business Legal document offering securities for sale. rule. (See also non-private customer.) Provides potential investors with detailed private equity information on the operations and Shares in unquoted companies. Usually business plans of the issuing company and high risk, high return in nature. their objectives or intentions for the use of the money. private finance initiative (PFI) System for providing capital assets for the protection overlay provision of public services. Typically, the Portfolio management technique by private sector designs, builds and which an investment manager aims to maintains and other capital protect the capital value of a portfolio assets and then operates those assets to through risk management techniques sell services to the public sector. In most such as dynamic hedging. cases, the capital assets are accounted for proxy voting on the balance sheet of the private sector Delegation of voting rights without operator. The pricing basis for the services attendance at a shareholders’ meeting. provided almost invariably includes an inflationary element.

60 P Q prudence put option Legal principle of “the prudent man” is Option which gives the purchaser the a measure by which the decision making of right, but not the obligation, to sell an the individual or organisation could be asset at an agreed price or an agreed date evaluated in comparison with what a (European option) or before an agreed reasonable person would have been date (American option). (See expected to do. also call option.) prudent man rule Common rule pertaining to fiduciary duty Bond that can be redeemed before in Anglo-Saxon countries. The OECD maturity at the option of the bondholder. states the rule in terms of the following PV01 broad principle: “A fiduciary should The change in present value of an asset or discharge his or her duties with care, skill, liability for a 1 basis point change in the prudence and diligence that a prudent curve used to value the asset person acting in a like capacity would use or liability. in the conduct of an enterprise of like character and aims.” Applications vary by country.

Prudential Regulation Authority (PRA)

Independent body formed as one of the successors to the Financial Services Q Authority (FSA), focusing on the prudential regulation and supervision of the financial QE services industry in the UK. See . public offering qualitative analysis Offering for sale of a new issue of securities Assessing the value of an investment by to the general investing public. Securities examining mainly non-numeric of such an offering will generally be placed characteristics such as management, through a syndicate, will have securities people, process, etc. issued in small denominations and will be listed on a stock exchange. An IPO is the quantitative (quant) analysis first public offering of a security. Use of mathematical and statistical techniques to make investment decisions. put-call parity (See also chartism, fundamental analysis.) Relationship that always exists between the price of a European put option and a European call option on the same underlying asset at the same strike price.

61 quantitative easing quorum Process by which a country’s central bank Minimum number of members (on an tries to stimulate the economy by increasing investment committee or board of trustees the amount of money in circulation. in the case of pension schemes) that is Quantitative easing is used in instances needed for a binding decision to be taken. when the central bank’s interest rate cannot

be lowered any further because it is zero or

very close to zero. The central bank

effectively prints new money and uses the

new money to buy fixed interest securities

from companies, usually banks. The intention is to encourage banks to increase their lending, which should eventually reduce the cost to of borrowing rack rent from banks and stimulate consumer Rent that would be received on a property spending. However, quantitative easing may if it were leased on the open market. The fail if institutions do not increase their current rent may be greater or less than lending despite the actions of the central the rack rent depending on the terms of bank. In addition, quantitative easing may the lease and how the market has moved lead to an over-stimulation resulting in a since the last rent review. rapid increase in inflation over time. rally Quantitative easing was adopted by the Considerable and sustained increase in the central banks of several countries during the price of a security or value of a market. global financial crisis of 2008/2009. random walk theory quarterly Theory that the price of an asset follows a Every three months. Usually refers to random path and therefore past price three-month periods ending 31 March, movements cannot be used to predict 30 June, 30 September and 31 December. future price movements. quartile rating (credit) One quarter of a sample. If returns of See credit rating. portfolios (or managers) are ranked in a league table, then, for example, a second real asset quartile ranking indicates that 25% of Asset whose value is linked (directly or portfolios performed better and 50% indirectly) to inflation. Equities, property, achieved a lower return — that is, the forestry, and inflation- return was in the second quarter (or 25%) linked bonds are often considered to be of the returns. (See also bottom quartile, real assets. (See also fixed interest asset.) top quartile.)

62 Q R real estate registrar Property in land, building or housing, as Organisation appointed to record the issue distinct from (e.g. cars); and ownership of company securities. also known as physical property, to rehypothecation distinguish itself from property trusts. Means by which a prime broker gains real interest rate access to bank loans. The prime broker’s Interest rate adjusted for inflation. If the clients (predominantly hedge funds) are nominal interest rate is 6% and inflation is required to post collateral with the prime expected to be 2% then the real interest broker for services such as securities rate is 4%. The definitions of real yield, real lending or leveraged investment rate of return, etc., are similar. transactions. Rehypothecation occurs when the prime broker subsequently real return reuses the collateral that was originally Inflation-adjusted return. posted by its client(s) to obtain a loan itself rebalancing from a bank. Making adjustments to a portfolio to relative return counteract the fact that different assets Asset’s or portfolio’s return over a period of have performed differently over a period, time relative to that of a chosen and thus comprise different percentages benchmark. Calculated as the difference of the portfolio than originally intended. between the asset’s absolute return and the benchmark’s performance. Two or more consecutive quarters of reinvestment negative GDP growth in an economy. Using the dividends, interest or profits redemption from an investment to buy more of that Repayment of an investor’s principal in investment. a security, such as a bond, at or prior REIT (real estate investment trust) to maturity. Particular type of pooled fund that invests redemption date in the property sector. See maturity date. growth redemption yield Growth in the rent of a property that could Calculation of the return that an investor be charged if the unit was let in the open will earn on a bond if he or she holds it to market on the valuation date. redemption, taking into account income and any or loss that will be made at the maturity date.

63 replacement ratio (defined Retail Prices Index (RPI) contribution) Measure of price inflation in the UK. It Amount of income (actual or projected) measures the average change from month that can be secured by an individual’s to month in the prices of goods and accumulated retirement savings at services purchased by most households in retirement, expressed as a proportion of the . Used for uprating his or her income before retirement. state pensions and benefits and calculating payments due on index-linked REPO gilts. (See also Consumer Prices Index.) See . retained earnings repurchase agreement (REPO) Company earnings that are not paid out Agreement to sell securities, usually as dividends. bonds, to another party and to buy them back at a specified date and price. return Increase in value of an investment over a responsible investment period of time, expressed as a percentage Integration of environmental, social and of the value of the investment at the start of corporate governance (ESG) the period. (See also money-weighted rate considerations into investment of return, time-weighted rate of return.) management processes and ownership practices in the belief that those factors can (ROE) have an impact on financial performance. Company earnings divided by shareholders’ funds. Provides an indication responsible investment policy to shareholders of how effectively their statement money is being used by the company. General (usually public) statement on responsible investment adopted by boards return seeking assets (RSA) of trustees or directors that directs A generic term which refers to the investment staff practices and decisions. proportion of a scheme’s assets invested This can be included within a broader in securities whose value is expected to investment policy statement and/or increase over time, at a faster rate, developed as a standalone responsible compared to its liabilities. investment policy statement. reversionary yield (real estate) retail fund Estimated market rental value divided by Assets managed on behalf of the direct the property value (market value of rent public in the form of a pooled fund. may differ from actual rental currently being earned).

64 R rights issue risk averse Issue by a company of rights to sell Preference of an individual or entity for new shares to existing shareholders in avoiding risk, however defined. In terms of proportion to their holdings. For example, a returns a risk-averse investor would seek a one-for-two issue allows each shareholder less volatile return unless he or she were to buy one new share for every two held. adequately compensated for the risk. Rights issues are a means of raising risk-free rate of return additional funds to finance acquisitions, Yield on a riskless investment (generally capital investment or reduce debt. one that has a government-backed ring-fencing guarantee and a known rate of return). For Act of separating investors’ assets from example, the yield on a government- those assets used to determine an issued three-month security is often taken investment bank’s net value. The as a measure of the three-month risk-free ring-fenced assets are usually held in return against which other riskier assets separate offshore accounts and are are measured. therefore protected from claims by risk premium creditors of the investment bank in the Additional return relative to the risk-free event of the bank’s failure. return expected from a risky asset to risk compensate for the additional risk. a. Likelihood of a return different from that (See also equity risk premium.) expected and the possible extent of the risk/return trade-off difference. Downside risk is the Amount of expected return that must be likelihood of a loss, or a return less than sacrificed in order to reduce risk. expected on an investment. b. Also used to indicate the volatility of risk tolerance different assets. (See also cash flow risk, Extent to which an investor is prepared to funding risk, investment risk, market accept volatility or risk in a portfolio. risk, solvency risk.) ROE risk-adjusted return See return on equity. Any measure of the return earned by an investment that is adjusted to take into rolling period returns account the level of risk taken to achieve it. Annualised returns over a given period ending with the date stated. This allows investors to compare the returns achieved over a specified period of time leading up to various dates over the holding period of their investments.

65 rolling settlement sale and System for settling share transactions Sale of an asset to a under which bargains are settled a number that then leases it back to the seller. It is of days after being transacted. used by companies to raise capital and may provide tax benefits. RPI See Retail Prices Index. satellite manager See core/satellite. running yield Annual income on an investment divided scenario analysis by its current market value, for example Quantitative analysis of the financial the dividend yield on equities. impact on an investor’s assets and liabilities of a defined set of economic and

financial conditions, usually projected over

the medium term. (See also asset/liability

modelling.)

S scheme sponsor Employer that sets up and funds a pension plan for its employees. Also called plan S&P 500 index sponsor. US large cap stock market index maintained by Standard & Poor’s. Its 500 Screening constituents represent over 80% of US Examination of various securities, usually equities by market capitalisation. through computer models, to identify certain predetermined factors such as S&P Composite 1500 Index valuations, earnings, liquidity, etc., with Combination of the S&P 500, S&P MidCap a view to the exclusion of those securities 400 and S&P SmallCap 600 indices. The not meeting the criteria from an 1,500 constituents represent 90% of US investment portfolio. equities by market capitalisation. scrip dividend haven Payment of dividends in the form of Investment whose value is expected to additional shares rather than cash. remain relatively stable during periods of high market volatility. For example, during scrip issue the credit crunch of 2008, there was a See bonus issue. “flight to quality” when many investors SDRT viewed government bonds as a safe haven See stamp duty reserve tax. from corporate debt of questionable credit quality and for which there was perceived to be a high risk of default.

66 R S SEAQ Securities and Exchange Commission See Stock Exchange Automated (SEC) Quotations System. Regulatory authority for the US securities industry. SEC See Securities and Exchange Commission. securities lending Process where one investor lends stock to secondary market another investor. The borrowing investor Market in which securities are traded after has to issue collateral to the stock lender they have been issued. (See also primary and usually borrows stock to engage in market.) “short selling” aiming to profit from falling secondary purchase stock prices. The lending investor usually Purchase of a holding in an existing private lends the stock to gain a return in the form equity fund from an investor who needs to of interest received from the borrower. sell. It can often be bought at a significant Passive fund managers may engage in stock discount. lending and use the earned interest to help regulate their fund returns so that they are sector more in line with benchmark returns. Stock markets are divided into sectors which comprise companies from the same securitisation industry — for example, Process of creating a tradable financial telecommunications sector, oil sector, instrument by combining other non- media sector, etc. tradable, usually loan-based assets and marketing them to investors. secular trend Long-term change attributable to an securitised property important fundamental shift in the Shares in property companies or in real economy or business environment that is estate investment trusts (REITs). not related to seasonal or cyclical factors. security For example, industrialisation, a. Term for fixed interest stocks or ordinary globalisation. (See also cyclical trend.) shares or, in general terms, for any secured bond tradable financial instrument giving title Bond for which the issuer has set aside to property or claims on income assets as collateral to ensure principal payments. repayment and encourage timely b. Assets or collateral pledged to support interest payments. debt obligations.

67 segregated portfolio share buyback Investment portfolio which is managed on Company’s repurchase of its own shares. behalf of a single client and has separately Typically increases the market price of the identifiable assets. See( also pooled fund.) remaining shares because each remaining share now represents a larger claim on self-invested personal pension (SIPP) earnings and assets. Investment vehicle that allows an individual to save for retirement by picking his or her shareholder activism own investments. The SIPP is essentially a Public or confrontational approach to UK government-approved tax wrapper shareholder engagement. In addition to which allows the individual to take shareholder engagement, pressure can advantage of tax savings on profits and be exerted on companies through income earned on his or her investments. strategic or attempts to influence public opinion. Debt issued by a company that has to be Sharia investment repaid before all other creditors in the Investment in companies whose practices event of the company’s liquidation. Senior conform with Islamic law. debt is usually secured by providing some form of collateral assets. Statistical measure of reward per unit of sensitivity analysis risk. Developed by William F. Sharpe, it is Analysis using mathematical tools of the calculated as the excess return over the extent to which small changes in a risk-free return divided by the standard particular variable, such as the weighting deviation of the excess returns. (See also in a certain security or market, may impact .) on portfolio return or volatility. shift settlement Measure of the degree to which a yield Payment or collection of proceeds after curve has moved upwards or downwards, trading a security. Settlement usually takes across all maturities, without changing its place some time after the deal and price overall curvature and slope. are agreed. short bias share Long/short fund with a net short position See ordinary share. and therefore positive exposure to a decrease in the underlying market. share blocking Mechanism that prevents investors who wish to vote their shares at annual meetings from trading for a defined period of time prior to the meetings.

68 S short position SIP Situation in which an investor sells a stock a. Statement of investment principles. that the investor does not own. The b. See UK Society of Investment investor is expecting the stock value to fall, Professionals. thereby making a profit when the position SIPP is closed at the lower price. (See also long See self-invested personal pension. position.) SIV short-term investment fund See structured investment vehicle. Alternative to a cash account which holds short-term, low risk investments. Often skewness used by investors holding large cash sums Describes asymmetry from the normal and have not decided where to invest distribution in a set of statistical data. these funds for the longer term. Skewness can come in the form of “negative skewness” or “positive SIA skewness”, depending on whether data Statement of investment arrangements. points are skewed to the left (negative See SIP. skew) or to the right (positive skew) of the SICAV data average. Legal structure of investment vehicle small cap stock that is common in some western European Stock with a market capitalisation of countries, for example, , among the smallest within a market, Switzerland, , Spain, Belgium and although the definition of what is small is France. A SICAV is open-ended, which to some extent arbitrary. In the UK, it is means that new investors into the scheme usually defined as a stock with a are not required to buy units from existing capitalisation below that of the top 350 investors. Instead, new units will be companies in the UK as represented by the created which investors may purchase. FTSE Small Cap Index. (See also large cap sin stock stock, mid cap stock.) Stock of a company that provides goods or socially responsible investment (SRI) services that the investor has deemed Idea and practice of investing based on unethical. Common examples include the ethical criteria, whereby companies stocks of companies that are involved in contribute to the welfare of society. the production or provision of tobacco, (See also ethical investment.) alcohol, armaments, pornography or gaming facilities.

69 Society of Investment Professionals Sortino ratio (SIP) Modification of the Sharpe ratio. Calculated UK member society of the Association for as the difference between the actual return Investment Management and Research and the risk-free return, divided by the (AIMR), an international non-profit downside risk. Here, downside risk is a organisation of investment practitioners measure of deviation of historical returns and academics. SIP oversees the falling below a specified target rate of Investment Management Certificate. return. (See also Sharpe ratio.) soft commission sovereign debt Arrangement whereby a fund manager Bonds issued by a government. directs commissions to a broker which are specialist management then used to purchase goods or services Where an investment manager’s mandate from a third party for the benefit of the is restricted to a specific asset class or fund manager. There are detailed FSA rules sectors, for example, UK equities. on the types of goods and services that Internationally, there is a strong trend may be softed. towards specialist management (away soft currency from a balanced or multi-asset approach). Currency of a country that is emerging or (See also balanced management, less developed with political and economic multi-asset management.) uncertainty. These countries tend to have currencies with volatile exchange rates. Investment in highly risky securities with (See also hard currency.) the expectation of making a profit from solvency risk price increases. In some instances, the Risk that an investor’s assets will be speculator’s decisions are not based on insufficient to meet its liabilities in the sound investment principles. future. Used in the case of UK defined spot exchange rate benefit pension plans, where liabilities are Exchange rate for immediate delivery. (See calculated as the costs of securing also forward exchange rate.) annuities with an insurer in the event of a plan wind-up. In the case of insurance spot interest rate companies, usually by reference to the Interest rate quoted on a day for loans statutory solvency tests. made that day. spot price Present market price of a commodity, currency or investment instrument.

70 S spread stamp duty Difference between the buying and selling Tax paid (in the UK and some other price or, in the case of corporate bonds, countries) by the purchaser on the transfer between the gilt yield and the corporate in beneficial ownership of certain types of bond-specific yield. asset — for example, UK equities and property. Stamp duty depends upon there being a document which can be stamped. Regulated activity in which wagers are For that reason, stamp duty reserve tax made on the range of possible outcomes of was introduced in the UK in 1986 to cater chosen events. The spread-better makes a for paperless transactions in shares. (See profit or loss based on the difference also stamp duty reserve tax.) between the actual outcome and the spread-better’s prediction. stamp duty reserve tax (SDRT) Tax paid on the transfer in beneficial SRI ownership of certain types of asset, for See socially responsible investment. example, units in UK unit trusts which SRPA invest in UK equities or property. (See See Style Research Portfolio Analyzer. also stamp duty.) SSAP24 Standard & Poor’s (S&P) UK accounting standard for the disclosure Independent rating agency which assesses of pension costs. Now replaced by FRS17. the creditworthiness of companies and their debt. The highest rating awarded is AAA, and the lowest is D. Other well-known Period characterised by low economic rating agencies are Moody’s and Fitch. growth and high , and accompanied by increasing inflation. standard deviation of return Statistical measure of the historical stakeholder pensions variability of returns relative to their mean Money purchase pension arrangements (or expected return). An indicator of the principally designed for people without degree to which an asset’s or portfolio’s access to employer-sponsored pension returns deviate over a specific period in arrangements and provided by absolute terms or relative to another asset commercial financial services companies. or benchmark portfolio. (See also mean, Stakeholder pension schemes must satisfy expected return.) a number of minimum government standards to ensure security, flexibility and value for money for members.

71 statement of investment principles (SIP) stock exchange Statement setting out the investment Market for trading in securities. policy being followed by a UK pension Stock Exchange Automated Quotations plan. Under the Pensions Acts 1995 and (SEAQ) system 2004, it is a legal requirement to have a SIP Screen-based trading system that shows and keep it up to date. set out bid and offer price quotations of all market a minimum level of content, and the makers in the UK. Myners Code recommends further additions to the SIP. (See also Myners stock lending Code, Pensions Act 1995.) Lending of stock from one investor to another that entitles the lender to continue start-up to receive income generated by the stock Finance used to form a completely new plus an additional payment by the company that aims to develop a new and borrower. There is potential risk as the unproven product or service. lender may be exposed if the borrower Sterling Overnight Interbank Average defaults, but the exposure is controlled Rate (SONIA) through high quality collateral (e.g. gilts) An index that tracks Sterling overnight provided by the borrower that is marked to funding rates for trades that occur in off market daily. Investors may wish to borrow hours. It is the rate that underpins the stock to cover short positions, for example. calculation of an interest rate curve used (See also mark-to-market, short position.) for sterling OTC derivatives stock selection that are transacted under “clean CSAs”. It Selection by investment managers of a is also the required rate of interest to be portfolio of stocks in a particular market or paid to counterparties on any cash received sector, usually based on technical or as collateral to support derivative positions. fundamental analysis and usually with the STIF aim of achieving a return superior to the See short-term investment fund. overall market or sector or benchmark thereof. stochastic modelling Statistical technique used in asset/liability stock-specific risk modelling to estimate the probability of Risk arising from a single stock holding, certain events occurring. It does this by usually where the holding represents a simulating many possible outcomes for position against a benchmark, in which the factors affecting the assets and case the term refers to risk relative to liabilities of the investor. A large number of the benchmark. outcomes are generated in order to derive a mean expected outcome and a statistical Purchase or sale of call and put options for distribution of outcomes. (See also asset/ the same underlying asset with the same liability modelling.) expiry date and strike price. 72 S style Purchase or sale of call and put options Approach followed by an active investment with the same expiry date but with manager in selecting stocks. (See also different strike prices. growth investor/manager.) strategic asset allocation style drift Benchmark allocation between the main Tendency of a portfolio manager to stray asset classes with the aim of meeting the from its investment philosophy and investor’s risk and return objectives. Also process to boost short-term returns. known as investment strategy or strategic Style Research Limited allocation and sometimes prefixed with Firm providing tools for the analysis of “long-term”. (See also benchmark, equity portfolios at the stock level, which investment strategy.) identify the particular style characteristics strike price of the portfolio and highlight the Price at which the holder of a call (put) components of risk relative to the option has the right to buy (sell) the portfolio’s benchmark. underlying security. Style Research Portfolio Analyzer STRIPS Tool developed by Style Research Limited Separately Traded Registered Interest and for analysis of portfolio style bias and risk. Principal Securities. Instruments created when the components of a bond (the Debt which ranks after all other to be principal and the coupons) are separated repaid if a company is liquidated. and traded individually. (Converts a Subordinated debt will be repaid before coupon-paying bond into a series of zero shareholders. (See also senior debt.) coupon bonds.) (See also coupon, principal, zero coupon bond.) sub-prime Describes loans which are considered structured investment vehicle (SIV) inferior or sub-quality due to the high risk Pooled investment vehicle which attempts of default by borrowers. Sub-prime loans to profit by exploiting differentials in granted in the United States property short- and long-term interest rates. SIVs market are generally considered to have are often set up by banks as independent sparked the credit crisis of 2008. units which do not impact directly on the bank’s balance sheet. In the stock market supranational debt crash of 2008, SIVs became unpopular Bond issued by an agency sponsored by a when it was revealed that they had been group of national governments — for heavily invested in non-transparent example, the . asset-backed securities.

73 survivorship bias systemic failure Tendency for samples of asset class returns Failure of the entire due to to include only the funds that survived a domino effect in the collapse of multiple until the end of the measurement period. financial institutions (e.g. banks). Funds that close due to poor performance systematic risk are often excluded, and sample average See market risk. return is thus biased upwards.

swap

Instrument designed to permit investors to

exchange payment streams for their

mutual benefit. Payments can be based on

interest rates, currencies or equity returns. T swap spread Difference in the yield available on a T+1, T+2, T+3 Abbreviations that refer to the settlement generic swap and a government bond. The date of security transactions. The T stands difference arises mainly as a result of the for the day the transaction takes place. The credit risk on the swap. (See also credit numbers 1, 2 and 3 denote how many days spread.) after the transaction date the settlement or the transfer of money and security Option granting the buyer the right, but ownership takes place. not the obligation, to enter into an interest rate swap on pre-defined terms. T-bill/T-bond See treasury bill, treasury bond. syndicated investment Investment which has been spread TAA See tactical asset allocation. amongst several institutional backers, generally because it is too large for a single tactical asset allocation (TAA) investor to provide all the finance required. Short-term deviation from a strategic asset allocation to exploit predicted synthetic investment short-term relative movements in markets An investment which simulates the return with the aim of generating excess return of an actual investment, but the return is relative to a benchmark (typically, the actually created by using a combination of strategic asset allocation). (See also financial instruments, such as options strategic asset allocation.) contracts or an equity index and debt securities, rather than a single conventional investment.

74 S T tactical asset allocation overlay technical analysis Portfolio management technique which Attempt to predict share price gains exposure to asset classes through movements on the basis of past patterns. derivatives rather than physical securities. (See also chartism.) Its economic exposure is typically much tender larger than the assets of the overlay Method of issuing securities whereby portfolio, which are used to fund margin investors are invited to bid, subject to a payments and close off positions. As a minimum price. The allocation of the result, it is used as an overlay to a larger securities is made according to the fund to adjust its asset allocation with the prices bid. aim of taking advantage of short-term movements and opportunities in tenor the markets. Length of a swap contract. TER A form of portfolio risk that arises when the See total expense ratio. possibility that an investment will move more than three standard deviations from term (of a bond) the mean or expected return, is greater Period remaining until the final payment. than what is shown by a normal term asset-backed securities loan distribution. facility (TALF) takeover Second economic measure implemented where one company by the Federal Reserve in the United makes a bid to acquire another. If the States, in which US$800 billion was issued target company is publicly traded, the to Congress to remove toxic securities acquiring company will make an offer for from US banks’ balance sheets during the the outstanding shares. 2008 credit crunch. (See also Troubled Asset Relief Programme.) TALF See term asset-backed securities term deposit loan facility. Bank deposit for a fixed period of time. The interest rate may be fixed at outset, target firm or variable. Firm that has been targeted by another firm for a takeover. term structure of interest rates Yield curve displaying the relationship TARP between spot rates of zero coupon See Troubled Asset Relief Program. securities and their term to maturity.

75 thin market time-weighted rate of return Market with few bid and ask offers. The Rate of return on an asset or portfolio that market is characterised by low liquidity, adjusts for the effect of cash flows. The high spreads, and high volatility. Also time-weighted return can be used to known as a narrow market. compare portfolio performances against each other and against market indices. tier 1 capital (See also money-weighted rate of return.) Describes the capital adequacy of a bank. Tier 1 capital is core capital that includes TIPS equity capital and disclosed reserves. See Treasury Inflation Protection Securities. tier 2 capital Tokyo Stock Price Index (TOPIX) Describes the capital adequacy of a bank. Index measuring the share prices of Tier 2 capital is secondary bank capital that selected companies listed on the Tokyo includes items such as undisclosed Stock Exchange. reserves, general loss reserves and top-down subordinated term debt. Approach to investment analysis which tiger economy starts from macroeconomic factors (GDP Nickname given to the economies of growth, interest rates, inflation, etc.) and Southeast Asia encompassing markets business cycle analysis to identify a such as Indonesia, , Malaysia, portfolio distribution across asset classes, Thailand, and China. then a country/currency mix, a sector distribution and ultimately a stock tilt selection. It is the converse of the Adoption of a particular view on a sector bottom-up approach. (See also bottom-up.) by overweighting or underweighting that sector relative to the portfolio benchmark TOPIX (e.g. a portfolio which was overweight See Tokyo Stock Price Index. resource shares and underweight top quartile industrials would be described as having a Quartile ranking that is in the top 25% of tilt towards resources and away from returns. (See also bottom quartile.) industrials). Toronto Stock Exchange (TSX) time value (of an option) Largest stock exchange in Canada, Part of a traded option’s value that can be historically home to a large number of attributed to the possibility of future natural resource companies. market movements adding to the value of the option. It is reflected by the difference between the traded price of the option and the intrinsic value of the option. (See also intrinsic value.)

76 T total expense ratio tracking error Total costs experienced by investors in Measure of the variability of investment an investment fund, divided by the total returns relative to a benchmark or index. It asset value of the fund. The total costs is usually expressed as the annualised include management fees (asset-based standard deviation of relative returns. Can or performance-related), transactions be expressed as either ex-post, which is costs, broking fees and auditor fees, simply the historical tracking error, or among others. ex-ante, which is a forward-looking estimate of the future tracking error. (See total rate of return swap (TRORS) also ex-post, ex-ante.) Contract in which one party receives interest and/or dividend payments plus tranche any capital gains and losses over the Packages created when a bond’s cash flows payment period on a reference asset (or are repackaged as a collateralised debt index, or portfolio of assets), while obligation (CDO) or a portfolio of securities the other receives a specified fixed is repackaged as a collateralised mortgage or floating cash flow unrelated to the obligation (CMO). Each tranche has a credit-worthiness of the reference asset. different risk/return profile, and the (Payments are usually based on the same tranches trade separately from one another. notional amount.) transaction costs total return Costs incurred when buying or selling Overall return on a stock or portfolio taking securities. These include brokers’ into account changes in capital values and commissions and spreads (the difference income earned. between the price the dealer paid for a security and the price he or she can sell it toxic asset for), market impact (security price Asset for which for which the secondary movements brought about by trading market has disappeared, on the basis that activity) and opportunity costs. the asset is expected to incur significant future losses. Investors holding toxic transition manager assets may be forced to sell these at large Manager whose specific role is to discounts to book value, in order to raise transition one portfolio of assets to another liquidity and stabilise their balance sheets. whilst minimising direct and indirect costs. treasury bill Bond issued by a government with a maturity of one year or less. Also called a T-bill in the US.

77 treasury bond trustee Bond issued by a government — for Individual or organisation responsible for example, US treasuries. the management and administration of a trust, for example, a pension plan, on Treasury Inflation-Protected Securities behalf of the beneficiaries of that trust. (TIPS) Index-linked (i.e. inflation-linked) bonds turnaround issued by the US government. Situation where a company that has had poor performance for an extended period trend analysis of time experiences a reversal of fortune. Type of technical analysis used to determine or locate significant trends in a security. turnover Measure of the level of trading in a triple bottom line market or portfolio. Usually expressed as Holistic approach to measuring a company’s the sum of the total value of purchases performance on environmental, social and sales in a period as a percentage of and economic issues. The triple bottom the portfolio value. line focuses companies not just on the economic value they add but also on the two and twenty environmental and social value they add Fee structure usually employed by hedge or destroy. fund and some private equity managers, with a base fee of 2% of the fund’s asset Troubled Asset Relief Program (TARP) value plus a fee of 20% of the Initial economic measure implemented outperformance of the fund. by the Federal Reserve in the United States in which US$700 million was issued to Congress to remove toxic mortgage- backed securities from US banks’ balance sheets during the 2008 credit crunch. (See also term asset-backed securities U loan facility.) trust deed UCITS Most UK pension schemes are formally Undertakings for Collective Investments in established as trusts, and the trust deed Transferable Securities. The UCITS is the governing document specific to each legislation governs how a fund can be scheme. The trust deed will set out the marketed within the European Union and trustees’ investment powers and any is designed to allow cross-border fund specific restrictions on permitted sales to investors of different nationalities. investments, etc. To obtain UCITS status a fund must invest within defined but wide parameters.

78 T U UK Society of Investment Professionals underweight (UKSIP) a. Exposure to a specific asset (or asset UK member society of the CFA Institute. class) which is lower than the proportion Formed by a merger between the Institute it represents in the benchmark against of Investment Management and Research which the portfolio is measured. (See (IIMR) and the London Society of also overweight.) Investment Professionals (LSIP). b. Specific rating within a three-part credit rating system which indicates whether a UKIPS fixed income security should be bought See United Kingdom Investment (overweight), sold (underweight) Performance Standard. or held (marketweight). (See also UKSIP overweight, marketweight.) See UK Society of Investment underwriting Professionals. Guarantee by an investor (usually an unauthorised unit trust investment bank) to a company issuing Unit trust that is suited to the needs of new shares or bonds that it will buy any institutional investors but cannot be remaining shares or bonds that are not marketed to the general public. bought by other investors. For providing this service, the underwriter will receive underlying security a fee but bears the risk that investors will Shares (or other securities) on which a not fully take up the issue and the derivative instrument is based. underwriter will be left with a large holding underperformance of stock. See outperformance. United Kingdom Investment undersubscribed Performance Standard (UKIPS) Situation where the demand for a new Incorporates GIPS and replaces the issue of securities is less than the number Pension Fund Investment Performance of shares issued. This is sometimes Codes (PFIPC). This has been approved referred to as an under-booking. by the National Association of Pension Funds (NAPF). (See also GIPS.) undervalued See overvalued. unit-linked fund Pooled fund usually operated by an insurance company or investment manager where the value of an investor’s holding in the fund is represented by the number of units held multiplied by the unit price.

79 unit price Value of a pooled fund unit, which may Debt obligation with no collateral, and be a bid, offer or mid price. The unit price backed only by the debtor’s is determined by reference to the net asset creditworthiness. value of the fund. Units may be unwind “accumulation”, where income distributions Reversal of an investment decision. For are reinvested, or “distribution”/“income”, instance, an investor who has bought a where income is paid away to unit holders. share can unwind the position by selling unit trust the share. Pooled fund that is established under trust upper quartile law in the UK. Unit trusts may be authorised See top quartile. or unauthorised. Only authorised unit trusts may be advertised for sale to the general public. The unit trust will create and cancel units as investors invest and disinvest — the number of units in existence from time to time will therefore V vary and it is not necessary for buyers to be matched with sellers. valuation universe Process of determining the value of a Term sometimes used to describe the total portfolio of assets, including any accrued number of operators or competitors in a income. (See also actuarial valuation.) particular field, or the number of available stocks from which a portfolio is selected. (VaR) Investment manager performance surveys Technique to analyse variations in are also referred to in this way. performance and to estimate the amount by which a portfolio could underperform. unlisted (stock) Company that is not available for purchase value date or sale through the stock market. Date agreed between parties for the settlement of a transaction. unrealised profit/loss The expected gain/loss on an investment value investment which remains unrealised until the Approach to investment which places investment or underlying securities have emphasis on identifying shares which are been cash settled. believed to be underpriced (on the basis of indicators such as P/E ratio and dividend yield) by the market.

80 U V volatility Degree to which a given set of number/ Variability of the price of a security. data points vary about the mean. It is the Typically quantified as standard deviation. square of the standard deviation. (See also standard deviation of return.) VC See venture capital. Forward contract for which the underlying is the volatility of a given product. This is a venture capital (VC) pure volatility instrument allowing Investment in a company that is at a investors to speculate solely upon the relatively early stage of development and movement of a stock’s volatility without is not listed on a stock exchange. A venture the influence of its price. capitalist raises money from investors to invest in such opportunities. These volume investments are typically risky but Number of shares or contracts traded in a potentially very profitable. Generally security or an entire market during a given considered a sub-sector of the private period, often used in the context of equity market. average daily or weekly volume. vesting volume weighted average price Acquisition by a pension plan member of (VWAP) an absolute right to an immediate or Benchmark for trading efficiency. It deferred benefit by fulfilling prescribed measures the average price at which a conditions, especially service share is traded in the market over a period, requirements. and can be compared against the price actually achieved by a fund manager. vintage year (private equity/ VWAP is calculated by adding up the infrastructure) monetary value traded for every Year in which a fund is closed and transaction (price times number of shares makes its first investment. traded) and then dividing by the total VIX number of shares traded in the period. Widely used index maintained by the voting rights Chicago Board of Exchange, reflecting the Entitlement of an ordinary shareholder to expectation of volatility in the market over participate in the running of a company by the next 30-day period. voting on resolutions. void rate (real estate) voting shares Percentage of a property that is vacant Shares that give the stockholder the right at a point in time. to vote at company meetings — for example, on the election of directors.

81 weak form efficiency Fund which buys securities in distressed One of the different degrees of the efficient investments, such as high-yield bonds in market hypothesis (EMH), suggesting that or near default, or equities that are in or current stock prices reflect and near bankruptcy. incorporate all relevant historic information. The weak form therefore

implies that technical analysis based on

such historic information cannot be used

to predict future stock prices.

W weighted of capital (WACC) Calculation of a firm’s overall warehousing that weights each source of finance Practice by a bank of taking on inflation proportionately (i.e. equity and debt). supply (e.g. from a private finance initiative [PFI] deal) and keeping this weighted average return inflation on its books with the expectation Rate of return that is weighted to take into of hedging it in the future by entering into account the relative sizes of the various an inflation swap with a pension fund. assets or funds which make up the sample. warrant weighting Certificate, attached to a security, entitling Proportion of an index or portfolio made holder to buy a specific amount of up of an individual or group of items, securities at a specific price. Warrants are usually expressed as a percentage — for valid for a specified period of time which example, the percentage of a portfolio may lapse either before or, in the case of invested in a region or any one stock. warrants to purchase common stock, on or white knight after the maturity of the debt security. Friendly potential bidder for a company Warrants are usually detachable and may usually sought out as an alternative to a be traded independently of the debt hostile bidder. security. Effectively warrants are long-term call options. widow and orphan stock Safe stock considered suitable for highly risk-averse investors.

82 V W Index WM Performance Services Total market index measuring the One of the main service providers in the performance of all US-headquartered UK that independently analyses the equity securities with readily available performance of pension funds and their price data. It is the most comprehensive investment managers. Part of the State index for the US equity market. Street group of companies. wind-up World Trade Organisation Process by which a company ceases to Supranational body established to operate as a going concern, and its assets encourage and supervise international and property are liquidated in order to trade between member nations. repay creditors. writer withholding tax Organisation or individual who sells (or Tax levied by overseas governments on grants) an option. dividends paid abroad. This may not be write-down reclaimable, even by tax-exempt investors. Investment which has been valued with-profits fund significantly below its original cost, but Investment product usually issued by an which is likely to recover at least part of insurance company, which pays bonuses its cost. to policyholders from the profits made on write-off the underlying investments. Policyholders Investment from which there is no may receive bonuses regularly and/or on likelihood of any recovery of the maturity. The underlying assets of the amount invested. with-profits fund usually include equities, bonds and property. W-shaped recovery Describes the change of an economic WM company indicator, such as unemployment or GDP, One of the main service providers in the during a recession when the indicator UK that independently analyses the experiences a sharp decline, followed by performance of pension funds and their a rally back to original levels, and then a investment managers. fall in value followed by another sharp rise.

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Y Z

yield Z-spread Return on an investment expressed as a Fixed number of basis points that would be percentage. Most often used to refer to the added to the gilt yield curve at all durations gross redemption yield on a bond, being so that the present value of a bond’s future the return to a purchaser if the bond is held payments equals its market price. Z-spread to maturity ignoring taxes and the is a measure of a bond’s credit risk. prospect of default. Another term for Therefore, it will be zero for gilts and high interest rate. (See also nominal interest for low quality corporate debt. (See also rate, real interest rate, redemption yield, nominal spread, option-adjusted spread.) running yield.) zero cost yield curve Simultaneous purchase and sale of options Relationship between redemption yields on the same underlying security for the and terms to maturity. (See also same period, with the same premium, but redemption yield, term.) at different strike prices. Hence, instruments such as zero cost collars yield curve risk (see collar hedge) can be engineered. Risk of bond price volatility due to changes in the shape of the yield curve. zero coupon bond Bond that pays no coupons. It is sold at a yield gap discount to its face value (assuming Difference between the redemption yield interest rates are positive) and matures at on long dated bonds and the average its face value after a specified term. See( equity dividend yield. also coupon.) zero coupon yield curve Differences in yields available on different Graphic representation of the market types of bond, for example, government yields for zero coupon securities plotted and corporate bonds. against the maturity of those securities. yield-to-maturity See redemption yield. YTD Year to date.

84 Y Z

85 ABOUT MERCER Mercer is a global consulting leader in talent, health, retirement, and investments. Mercer helps clients around the world advance the health, wealth, and performance of their most vital asset — their people. Mercer is a wholly owned subsidiary of Marsh & McLennan Companies. As a leading global provider of investment consulting and fiduciary management services, we offer customised guidance at every stage of the investment decision, risk management and investment monitoring process. We have been dedicated to meeting the needs of clients for more than 40 years and work with the of pension funds, foundations, endowments, corporates, banking, and insurance companies, as well as government and local authorities and other investors, in over 41 countries. We assist with every aspect of institutional investing (and retail portfolios in some geographies), from strategy, structure and implementation to ongoing fiduciary management. Mercer’s Investments business has over 2,100 employees in more than 50 offices globally whose combined expertise provides effective solutions for our clients’ challenges and objectives.

86 OUR SERVICES We provide advice to more than 3,300 institutional investors, on more than $7 trillion in assets, with all aspects of investment-related advice, including:

• Implemented solutions. • Custodian evaluation and selection. • Financial analysis and risk management. • Investment administration and • Setting investment objectives. implementation advice, including OTC derivatives. • Asset allocation advice, including asset- liability modelling. • Investment manager operations and implementation assessments. • Investment manager structure. • Investment efficiency, operations and • Investment manager research and implementation monitoring. evaluation. • Asset transition assistance and transition • Monitoring of strategy and investment manager evaluation and selection advice. management against objectives. • Advice on brokerage, trading and • Consulting on multinational retirement commission arrangements. plans. • Securities lending advice. • Defined contribution programme consulting. • Investment operations and implementation governance. • Consulting on responsible investment. • Surveys and benchmarking. • . • Training and investor education. • Dynamic asset allocation. • Mercer Dynamic De-Risking Solution.

87 DIVERSE BACKGROUNDS Mercer has an undeniable advantage in the diverse range of skills and backgrounds of our staff. We encourage our consultants to think broadly and proactively. In Europe, we employ over 500 specialists with investment consulting, investment management, plan sponsor and actuarial backgrounds. Each specialist has access to our global network of over 1,300 specialists’ expertise to support our clients with industry-leading ideas to help improve returns, control risk and reduce costs.

WHY MERCER? Mercer’s strength lies in our ability to provide advice that is proactive, insightful and tailored to your specific needs. We deploy an exceptional level of resources towards the development of our intellectual capital, tools and consulting services. By building a dynamic working relationship, we help you achieve your objectives by providing you with the right tools, advice and practical solution, and create value by applying our extensive knowledge to solving your investment challenges. We believe that our people, expertise, ability to generate industry-leading ideas and global resources distinguish us from our .

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