Glossary of Terms

This glossary is intended to assist you in understanding commonly used terms and concepts when evaluating an investment.

1. Investment Asset Classes

Cash

Cash refers to funds that are held on individual or pooled bank deposit accounts, and may also include money market funds and high-quality liquid bonds with a maturity period of less than 1 year.

Cash is generally considered to be a safe investment with virtually no risk of capital loss.  Moreover, it is a liquid and generally accessible asset, although the investment return is entirely dependent upon interest rates and, as such, only provides a ‘real’ return if the accruing rate of interest exceeds inflation.

Fixed Interest

Fixed interest, or bond investments, are issued by supra-national agencies, governments, companies and other institutions as a means of raising money.A bond is effectively a loan given to the issuer of the bond.

Bonds generally pay a set rate of interest over a given period, then return the investor’s principal (the amount the investor has ‘loaned’ to the issuer of the bond) at the end of the term.

Bonds offer a predictable nominal return over time which is generally greater than the interest rates on cash deposits, but they may be subject to short-term volatility.

'Sovereign bonds' issued by governments (in the UK these are known as 'gilts') are regarded as carrying lower risk than 'corporate bonds' which are issued by companies.The primary risk is the bond issuer defaults by not paying the interest payments due and/or not repaying the investor at maturity.

Bonds are rated by credit-rating agencies to provide a measure of the level of creditworthiness of the issuer of the bond(s), be it a country or a company. An issuer with a poor rating will have to offer a higher rate of interest to attract investors. Bonds issued by lenders with the lowest credit rating are known as 'junk bonds'. Bonds with the highest credit rating are the most liquid and thereby the easiest to buy and sell.

Bond prices generally reflect interest rates, although they have an inverse relationship which means that bond prices fall as interest rates rise and vice versa. In addition, prices are affected by the number of years left to maturity with longer-dated bonds displaying more volatility than shorter-dated bonds which are less sensitive to interest rate movements.

Some bonds have fluctuating interest rates although the majority have fixed interest payments.

Commercial Property

Investment in commercial property entitles the investor to receive rental income as well as the opportunity for capital appreciation. The expected returns and the protection from inflation are generally regarded as being somewhere between fixed interest and equities. The primary drivers for the return achieved are supply and demand.

The usual form of investment in ‘bricks and mortar’ is purchasing shares or units in a property fund or property trust and these can provide exposure to a diverse range of different types of property including retail, commercial and industrial buildings (which may include some commercial development into residential units) both in the UK and overseas.

Property can be one of the least liquid investments because of the time that it can take to dispose of a building, although this can be improved by investing through a collective fund or trust. However, open-ended funds are likely to underperform a rising market, and the illiquidity of property means that funds may refuse redemptions for extended periods while cash is raised.

Investing in collective funds which invest in the shares of property companies can significantly increase the liquidity, but the volatility can mirror that of the wider equity markets, particularly over a shorter investment period.

Equities

An investment in the shares of a company entitles the holder to a share of the company profits in the form of a dividend payment. Shares are either privately held or publicly traded (listed) on public stock exchanges around the world. Normally, dividend-paying companies are established, mature and profitable businesses. Over the long term the value of a company share reflects the success of the company as expressed by the value of the current and expected future dividend payments.

Shares can be bought in companies of different sizes, maturities, sectors, regions and countries. Shares prices can fluctuate greatly and in the case of overseas shares, or UK-listed companies with a significant proportion of overseas earnings, are influenced by currency movements and exchange rates. The fluctuations in the values of shares means that they should be regarded as longer term investments.

Historically shares are regarded as being riskier than bonds but provide a higher level of compensation for taking these risks, and because company profits are not fixed and generally rise in-line with inflation, investing in equities can be a form of protecting capital against the impact of inflation.

Most shares are easily traded with shares in large, blue-chip companies having the greatest liquidity.

Alternatives

Alternative investments cover all non-traditional asset classes and are often included in portfolios because they can act as useful diversifiers.

The most common forms of alternative investments are: absolute return strategies, private equity, structured products, infrastructure and commodities. Other forms of alternative investment include land, forestry, works of art, antiques, stamps, classic vehicles and wine.

The lack of correlation of some these assets with traditional asset classes can serve to reduce risk within a portfolio as well as providing the opportunity for attractive returns when other forms of investments are performing poorly. Some alternative investments can be complex as well as being less liquid than some other asset classes meaning that they can sometimes be more difficult to sell.

Please note that because our Model Portfolio Service invests only in collective funds on retail wrap platforms we are limited in the availability and our ability to access certain forms of alternative investments.

Absolute return strategies: the managers of these investments employ different strategies and sophisticated techniques with the aim of producing a positive return regardless of the direction and the fluctuations of capital markets. Hedge funds are a form of this type of alternative investment although they remain generally unavailable to retail investors because of high minimum premiums together with high charges.

Commodities: this area of investment is split into two types: hard and soft commodities. Hard commodities are typically natural resources that must be mined or extracted (gold, iron ore, rubber, oil, etc.), whereas soft commodities are agricultural products or livestock (corn, wheat, coffee, sugar, soybeans, pork, etc.). The prices of commodities can exhibit significant volatility based on a supply/demand characteristics and currency fluctuations. Consequently, investing in commodities using a collective fund can help to spread the risk.

Infrastructure: this usually encompasses investment in buildings (hospitals, schools etc.) and transport (bridges, tunnels, roads, railways, and airports) in the form of a public private initiative where government and private enterprise come together to develop projects for the benefit of society. These investments can be attractive because they generally offer high and growing income yields and are usually accessed through collective funds or trusts. An alternative means of gaining access to this sector is to invest in a fund which selects the shares of companies involved in this sector.

2. Performance Measurement

Private clients want to know how their investment portfolio is doing in monetary terms as well as compared with the market. However, there is a confusing array of performance measures available, but which one is best?

A benchmark is a measure against which the performance return of an investment or portfolio can be compared. Historically, the most common form has been to use either broad-equity market indices, such as the MSCI World Index, or market segment indices such as the FTSE 100 Index.

For diversified portfolios the benchmark has often been a combination of indices including equities, bonds and cash in appropriate proportions. Whilst this method is both simple and transparent the lack of any cost built into indices, which indices to select, and the pre-defined ‘neutral’ asset allocation of the proportions of the chosen indices detract from its value.

Many private clients prefer to assess the performance of their portfolio against an appropriate peer group. This has a twofold advantage in so much as an investor can compare with the average as well as each of the contributors to that average. This is known as peer grouping and brings advantages as the private client investment management industry has moved from a static asset allocation benchmarks to a more risk-based approach.

At present, the Parallel Portfolios are benchmarked against a range of Investment Association (IA) sector averages. The selected IA benchmark is detailed on each portfolio fact sheet and varies generally according to the maximum exposure to equities within the portfolio.

As well as the IA benchmarks we also provide indicative return targets for each of our portfolios. These are expressed as an annual percentage and are the expected average annualised return over a rolling five-year time horizon. Each of our portfolios aims to generate a return which exceeds consumer price inflation (CPI) and so these return targets range from CPI+1% for our most defensive portfolio to CPI+6% for our most aggressive portfolio.

It should be noted that these return targets do not guarantee the level of return to be achieved but provide guidance to investors of our expectation of the return from our portfolios.

3. Other Terms

Risk is defined as the chance that an investment's actual return will be different than expected. This includes the possibility of losing some or all of the original investment. Risk comes in a number of forms including market risk (the day to day fluctuations in asset prices) and shortfall risk which is the possibility that a portfolio will fail to meet longer-term objectives.

Volatility is a measure of risk and is often reported using ‘standard deviation’. The standard deviation of an investment or portfolio measures the degree to which its price or value fluctuates in relation to its average return over a given period of time. A volatile investment or portfolio is considered higher risk when its performance could change quickly in either direction at any moment. For the Parallel portfolios we quote the standard deviation over a rolling 5-year period and each portfolio has a volatility range used as a means of both monitoring and managing risk.

Annual Management Charge (AMC) covers the cost of the manager’s investment management services, such as research analysis and portfolio management. The fee is deducted from the fund and is levied as a percentage of the value of the fund’s assets.

Ongoing Charge Figure (OCF) represents the ongoing costs to the fund, which includes the AMC and charges for other services such as keeping a register of investors, calculating the price of the fund’s units or shares and keeping the fund’s assets safe. The OCF is charged as a percentage of the value of the fund’s assets but does not take account of any initial charges or the costs of trading the underlying stocks and securities held.