Jargon buster! What key funds management terms mean

min read

Don’t get lost in investment portfolio terminology.

Nearly everyone is invested in the local sharemarket directly or indirectly (through their super) these days and it’s important to understand how your investment portfolio or superannuation may be performing. But it’s all too easy for investors to get lost in investment concepts and jargon they barely understand.

Here are some key investment terms and their meaning:

1. Benchmark
A benchmark (also known as an index) is a collection of assets that provide a broad representation of an asset class. It is designed to act like a barometer for the performance of that asset class. For example, the S&P/ASX 200 is a sharemarket index that includes the top 200 ASX-listed companies. Each company has a specific weighting in the index based on its market capitalisation. Commonwealth Bank of Australia has the highest weighting, at 9.4 per cent at 27 April 2016.

2. Overweight/Underweight
The expressions overweight and underweight generally relate to the weighting of assets that an investor holds in their portfolio, compared to the benchmark index. If an investor has a portfolio weighting of CBA shares above 9.4 per cent, they are overweight this stock, and vice versa for underweight.

3. Asset allocation
Asset allocation describes the amount spread across each asset class in a portfolio or managed fund. For example, a typical “balanced” portfolio may include an allocation to Australian and international shares, Australian and global fixed income, property, alternatives and cash.

4. Alpha
This is typically defined as the performance return of an asset above its benchmark. For example, if a fund achieves a return of 7 per cent against the benchmark return of 5 per cent, the alpha generated is 2 per cent.

5. Beta
Beta measures the extent to which the value of an asset (or fund) moves in line with the benchmark index. For example, a Beta of 1 means that the performance of an asset mirrors the index, so they move in tandem and are equally volatile. A Beta value above 1 means the asset’s price movements are more amplified than the benchmark, and vice versa for a Beta value below 1.

6. Risk-adjusted return
Measures the performance of an investment, with respect to the risk involved in achieving that return. A risk-adjusted return helps determine if investors have been adequately rewarded for a higher-risk investment by receiving higher returns. It also helps compare the returns of investments that may have different risk-and-return profiles, to make a better like-for-like comparison.

7. Unit trust
A form of pooled investment fund. A unit trust offers multiple investors a share in the underlying assets that make up the fund, by purchasing units. The price of the unit is calculated by dividing the total value of all assets in the unit trust by the number of units. The benefits of a pooled unit trust is that it allows investors to access institutional investments they would otherwise not be able to afford on their own, and gives investors access to a potential wider range of investment opportunities.

8. Passive investment
Passive investment funds aim to replicate the performance of a benchmark index, either by matching the investments of the index or through a close sample. The upside of investing in a passive fund is that investors are generally not expected to underperform the index. However, the flipside is that there is generally no opportunity to outperform.

9. Active investment
An active investment strategy may appeal to investors who believe that actively selecting assets can deliver a performance return above a given index. For example, rather that matching a benchmark index, an active share investor will aim to overweight stocks that are expected to outperform the index, and underweight stocks that are likely to underperform. If this active strategy proves correct, the investor can potentially outperform the index.

10. Top-down/bottom-up investing
These are two common approaches to investment. Top-down investment emphasises first analysing economic and global trends, then developments affecting particular industries, and finally which companies are expected to outperform in those industries, and investing on that basis. Bottom-up investment focuses primarily on companies in order to determine where to invest, with little emphasis given to economic trends.

11. Benchmark aware/unaware
A benchmark-aware investment strategy will determine portfolio holdings with respect to an underlying benchmark index, such as the S&P/ASX 200. Each position in the portfolio is then referenced as an overweight or underweight holding, relative to the index weight.

A benchmark unaware strategy will result in portfolio holdings that are irrespective of their benchmark weightings. A benchmark-unaware strategy is typically used where an index is not appropriate, such as an absolute return or unconstrained strategy.

12. High/low liquidity
This term describes how quickly assets can be sold or converted to cash, with minimal transaction cost. For example, a short-term bank bill is a highly liquid asset as it can be easily converted into cash. Direct property is a low-liquidity asset as it cannot be sold quickly and there is generally a considerable transaction cost.

13. Underperformance/outperformance
Measures the performance of an investment relative to its benchmark index. Underperformance is used to define an investment falling short of its benchmark return, while outperformance explains the performance of an investment above its benchmark.

Understanding investment concepts and jargon is only the first step in becoming a successful investor. Whether or not you use the services of a financial planner, it pays to fully understand the investments you are investing in and have a well-diversified portfolio that meets your own return and risk objectives.

If you are not confident in choosing the right stocks of assets in your portfolio, a managed fund may be the answer. Managed funds provide an opportunity to have your investment professionally managed, with access to a range of investments that may be difficult for individuals to achieve on their own.

About the author

Legg Mason is one of the world's largest fund managers, with a history that dates back to 1899. In Australia, Legg Mason and its investment affiliates manage more than $30 billion for both institutional and retail clients. Legg Mason offers a large number of investment funds covering a range of asset classes, including Australian equities, global equities, emerging markets, fixed income, real assets, income, alternatives and multi-asset products. Legg Mason has a range of managed funds that are available via the ASX mFund Settlement Service. More about Legg Mason here.

Follow on Twitter: @leggmason

From ASX

ASX Glossary helps new investors comprehend investment terms, and learn the "language of the sharemarket".

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