Investment terms by letter
Accredited Investor – While additional criteria also apply, in general, “Accredited Investors” are individuals with a net worth of $1 million or annual income of $200,000 (or $300,000 joint income with a spouse); or entities with a net worth of $5 million.
Alpha – Measures the excess return of a portfolio above the expected return as established by comparison to a benchmark or by a financial model. The higher the alpha, the more outperformance.
Backwardation – Please see Roll Yield.
Beta – Measure of the volatility systematic (market-related) risk, of a portfolio as compared to the overall market. The lower the beta, the lower the exposure to market risk (volatility).
Buyout – An investment in which ownership equity is acquired in an existing company or division of a company. The seller could be the parent company, public shareholders or a private equity investor. Most buyouts involve significant leverage and are known as leveraged buyouts (LBOs). If the present management of the business participates in the buyout, the transaction is known as a management buyout (MBO).
Commodity – A commodity refers to a tangible good, rather than a financial asset. Commodities are consumed either directly or indirectly by individuals every day including such goods as industrial and precious metals, oil and natural gas, and agricultural products.
Contango – Please see Roll Yield.
Correlation – A measure of strength of the linear return relationship between two assets and their movement, correlation can be any value between +1 and -1. Greater portfolio diversification can be achieved by combining investments that have lower correlation to each other. Correlation of +1 means assets moved in the same direction when markets changed. Correlation of -1 means assets moved in the opposite direction when markets changed.
Credit risk – The risk of loss of principal or loss of a financial reward stemming from a borrower’s failure to repay a loan or otherwise meet a contractual obligation.
Derivatives – Contracts entered into for the purpose of exchanging value on underlying securities or physical assets. Generally, derivatives are used for operational efficiency or to control transaction costs.
Fund of funds – A fund that allocates to multiple funds and possibly to direct private transactions as well. One benefit to this approach is that investors gain broad exposure to different strategies and managers for a smaller initial investment (compared to investing in each one separately). In addition, a professional manager selects investments and provides oversight, deciding when to buy, sell or reallocate. Funds of funds tend to have additional fees in compensation for this professional management.
Futures/Futures contract – A future is a standardized financial contract between two counterparties in which the buyer agrees to buy an underlying asset (e.g., financial instruments or physical commodities) at a pre-determined future date and price.
Hedge funds – Hedge funds are private pools of investment capital with broad flexibility to buy or sell a wide range of assets. One common attribute is that they seek to profit from market inefficiencies rather than relying purely on economic growth to drive returns. There is no “one-size-fits-all,” and the types of investment strategies pursued by individual hedge funds are extremely diverse.
Idiosyncratic risk – Risk that arises from the circumstances or characteristics of trading a specific security rather than from market movement or other macro-economic factors.
Information ratio – A ratio of portfolio returns above the returns of a benchmark compared to the volatility of those returns. Information Ratio measures a portfolio manager’s ability to generate excess returns, but also attempts to identify the consistency of the manager. This ratio will identify if a manager has beaten the benchmark by a lot in a few months or a little every month. Therefore, a higher Information Ratio equals better risk-adjusted return (i.e., more consistency of outperformance).
Infrastructure – A real asset that includes both economic infrastructure projects (such as roads, bridges and utilities) and social infrastructure (schools, hospitals). Infrastructure companies often act as a monopoly in the provision of a facility or service of an agreed standard.
Interest rate risk – The sensitivity of a bond or fund to changes in interest rates, as measured by duration. In the event of an interest rate increase, higher interest rate risk (longer duration) would correspond with a decrease in price.
Leverage – The use of financial instruments or borrowed funds to amplify performance. In an upward- or downward-trending market, a leveraged investment that is on the correct side of the trend will see magnified gains, while one on the wrong side of the trend will see magnified losses.
Liquidity – Liquidity refers to the frequency at which investors are able to access their investment capital. When investing in alternatives, the liquidity terms of specific funds are aligned to liquidity profiles of the underlying investments. For example, alternative investment mutual funds trade in highly liquid securities (e.g., stocks, bonds), are valued daily and return of capital is within a few days if an investor redeems. Because traditional alternative fund vehicles—hedge funds, for instance—often invest in more complex and less liquid investments, they tend to offer more limited liquidity. Typically, investors must pre-notify the fund of their intention to withdraw capital, and payment of proceeds is at a pre-specified later date. For other long-term investments such as private equity, investors remain committed for longer periods of time (e.g., 5 to 10 years or more). Generally, less liquid investments are expected to offer a higher return to compensate for these constraints, often referred to as an “illiquidity premium.”
Long/Short – An investment strategy that uses leverage to buy securities that are expected to increase in value (go “long”) and sell borrowed securities that are expected to decrease in value (“short selling” or “shorting”). The goal of shorting is to buy the same securities back for a lower price at a future date, thereby profiting from the difference. Whereas long-only investing enables profits from a positive outlook on a security, long/short investing also allows the manager to profit from a negative outlook.
Market neutral – An investment strategy that seeks to hedge out all or a significant majority of market risk by taking offsetting long and short positions, resulting in extremely low or zero market exposure.
Net market exposure – An indication of the sensitivity of a long/short fund to direction and volatility of markets. Lower net exposure typically means less direct impact from overall market movements.
% LONG SECURITIES – % SHORT SECURITIES = % NET MARKET EXPOSURE
Option-adjusted spread (OAS) – A measurement tool for evaluating price differences between bonds with embedded options. A higher OAS typically indicates a riskier bond.
Private equity – Ownership interest in a company or portion of a company that is not publicly owned, quoted or traded on a stock exchange. From an investment perspective, private equity generally refers to equity-related finance (pools of capital formed through funds or private investors) designed to bring about some sort of change in a private company, such as helping to grow a new business, bringing about operational change, taking a public company private or financing an acquisition.
Qualified Purchaser – While additional criteria also apply, in general, “Qualified Purchasers” are individuals with at least $5 million in investable assets or entities with at least $25 million in investable assets.
Real assets – Physical assets valued for their intrinsic worth, such as commodities, REITs, inflation-linked bonds, private real estate and infrastructure.
Real Estate Investment Trust (REIT) – An investor-owned corporation, trust, or association that sells shares to investors and invests in income-producing property.
Risk budgeting – An approach to portfolio construction focusing on analysis of its main sources of risk. This approach forecasts expected volatility and correlation between underlying assets and securities to project total portfolio volatility. By using risk budgeting, portfolio managers allocate investments across the portfolio in line with the targeted level of risk.
Roll yield – “Rolling” a futures contract means closing out a position in an expiring futures contract and establishing an equivalent position in a contract in the same commodity with a future expiration date.
When the futures curve is upward sloping, i.e., the price of the contract is expected to increase (contango), this results in negative roll yield (loss).
When the futures curve is downward sloping, i.e., the price of the contract is expected to decrease (backwardation), this results in positive roll yield (profit).
Sharpe ratio – Measurement of an investment’s excess return per each unit of additional risk (as measured by standard deviation), compared to a risk-free asset. Sharpe Ratio indicates whether portfolio returns are due to smart investing or excess risk. In other words, the higher the Sharpe Ratio, the better the risk-adjusted return, calculated as:
S = (return of the portfolio – return of the risk-free asset) / standard deviation of the portfolio
Signal decay – How quickly new investing “signals” are incorporated into a security’s price. An example of a signal would be an analyst increasing the earnings outlook for a company. In efficient markets, that information is incorporated into the security’s price quickly, resulting in fast signal decay. In inefficient markets (e.g., certain emerging markets) information tends to be priced in more slowly.
Standard deviation – A measure of the total volatility, or risk, of a portfolio. Standard deviation indicates how widely a portfolio’s returns have varied around the average over a period of time. A lower standard deviation means less variance of returns and therefore lower level of risk.
Transparency – Transparency refers to the level of disclosure and access to portfolio reporting, such as underlying holdings and risk metrics (i.e., not just portfolio performance). For certain fund types such as alternative investment mutual funds, specific transparency and reporting is mandated. For other types of funds, transparency is often optional and at the discretion of the fund manager.
Venture capital – Funding provided by investors to start-up companies with less access to capital markets but a high potential for growth. Typically, venture capital investments have a high risk profile but also the potential for above-average returns.
Volatility – Variations in the performance of an investment, commonly measured by standard deviation relative to a mean or benchmark. High volatility is associated with higher risk, as large swings in performance can make it more difficult to anticipate the outcome of an investment over the long term.