ii rated products methodology

Glossary

Asset Class Definitions

Equities
Also known as shares, equities represent a share in the ownership of a company. The investment return from holding equities is made up of:

• capital gains (or losses) from the rise (or fall) in price of the share; and
• dividends, a sum of money paid regularly by a company to its shareholders out of its profits (or reserves)

Investors are able to buy and sell shares in companies across the globe. These include:

• UK equities: UK equity funds invest in shares listed on the London Stock Exchange. These include shares in large companies in the FTSE 100 index, through to the next 250 largest in the FTSE 250, all the way down to the smallest companies. There are a large range of funds available.
• UK smaller companies: Funds that invest in UK smaller companies specifically look at the smallest companies listed on the London Stock Exchange. Typically the shares are newer, with a shorter track record. This means they are considered higher-risk than larger, more established shares with a longer track record. The sector also includes Alternative Investment Market (AIM) stocks. AIM is the London Stock Exchange’s international market for smaller growing companies.
• Global equities: Funds that are called Global Equity funds give investors exposure to markets in all geographic areas across the world. These funds differentiate themselves by having to not only choose which underlying shares to buy, but also how much to invest in each region. 
• Emerging markets: Countries that have a lower per-capita income and are moving towards becoming more developed. These regions typically do not have an established track record and come with higher risks for investors. 
• Asian equities: Asian equities include all countries from the region, including very established markets like Japan and Hong Kong, newer developed markets like China and Taiwan and those that are still developing, such as Malaysia and Vietnam. Most Asian funds have larger weightings to the bigger markets and only a small weighting to emerging Asian markets.
• European equities: European equities include all countries from the region, including very established markets such as Germany and France, newer developed markets such as Poland and Russia and those that are still developing, such as Latvia and Croatia. Most European funds have larger weightings to the bigger markets and only a small weighting to emerging European markets. 
• US equities: These funds invest in shares listed on stock exchanges in the United States. These include the largest US companies in the S&P 500 index all the way down to the smallest companies in the US that are often members of the Russell 2000 index. There are a large range of funds available.
• Japanese equities: As the most developed market in Asia, investors often want exposure to Japan separately to other Asian countries. The main Japanese market index is the Nikkei 225. The Nikkei measures the performance of 225 large, publicly owned companies in Japan

Equity Income
Equity Income is a specific investment strategy where fund managers aim to invest in shares in companies that pay dividends – regular annual or quarterly cash payments to investors out of profit or reserves. While most larger stocks pay dividends, smaller companies that are starting out typically do not pay out as much as they reinvest profits in growing their business. Equity income fund managers typically try and invest in stocks that pay larger than average dividends to generate a stable regular income for those investors who want it.

• UK equity income: UK Equity Income fund managers invest in dividend paying stocks from the London Stock Exchange (typically these will be larger, established, companies) to generate a stable income for investors looking for regular income from their equity investments.
• Global equity income: Global Equity Income fund managers invest in dividend paying stocks from around the world (typically these investments will be in larger, established, companies) to generate a stable income for investors looking for regular income from their equity investments.

Fixed income
Fixed income is another term for bonds.  These are loans taken out by a government or company which it promises to repay over a fixed timeframe along with a regular interest payment (in effect, the rate paid annually or semi-annually on the loan).  

• Global bond funds
  Funds that invest at least 80% of their assets in fixed interest securities. 
• Sterling bond funds
  Funds that invest at least 80% of their assets in sterling denominated bonds (or bonds hedged back to sterling).

Alternative Investments
Most investments are either categorised in the equity or fixed-income sectors. But there are many other ‘alternative’ investments you can choose, and these include commercial property (investments in shops, offices and warehouse) and commodities (raw materials such as gold, copper, oil or agricultural products such as wheat and coffee). These ‘alternative’ investments can play an important diversifying role, having the potential to mitigate losses when equity and/or bond prices are falling. Research shows that a modest allocation to carefully selected alternatives can reduce overall portfolio volatility without materially impacting the overall expected return.

• Property
  Real-estate assets, usually comprising business premises rather than residential properties.  These typically include retail (individual shops or shopping centres), retail warehouses, offices and/or industrial premises. The fund manager will earn a rental yield on the premises it owns in its portfolio, as well as making a capital gain/loss on any changes in the underlying value of the properties it owns.
• Specialist
  Funds within the specialist sector are ones that have an investment universe that is not accommodated by the mainstream sectors. This sector contains a diverse range of investment options. A number of these funds are commodity orientated, but it can include a wider range of non-standard financial assets, e.g. infrastructure.  

Mixed asset
Fund managers in this sector have a mandate to invest in assets across a range of different asset classes, e.g. equities plus fixed income plus potentially cash. These funds typically specify the maximum amount they have invested in equities, which allows customers to choose how much exposure they want.

Other terms

Passive investing
Passive investing, also known as index tracking, is where a fund follows a set benchmark (usually a stock market index such as the FTSE 100 or S&P 500) and aims to replicate the performance of that benchmark for investors. 

Ongoing charges figure (OCF)
The annual cost of investing in a fund, expressed as a percentage of the value of your investment. Trading costs (incurred when the fund manager buys or sells investments held by the fund) are not included in the OCF, so the true annual cost will be higher than the stated OCF. The total cost of the fund calculates everything included in the annual running costs. Please note that all performance figures are calculated net of all costs incurred in running a fund.

Risk profiling
Individual funds will generate returns that vary dependent on their underlying holdings and the behaviour of the market as a whole. Risk profiling allows us to measure how a fund performs in different scenarios and whether the returns it achieves are based on higher than normal risks, or good management. The aim is to try and identify funds which achieve good returns for the level of risk they take.

Sharpe ratio 
A useful aid for investors hunting for active funds that stand out from the crowd. The Sharpe ratio is a way of measuring the historical risk-adjusted return on an investment. In other words, how much excess return (over and above a risk-free rate, e.g. yield on government bond) you have received for each ‘unit’ of risk being taken by the portfolio manager. The higher a fund's Sharpe ratio, the better its returns have been relative to the risk it has taken.

The Sharpe ratio is calculated as the return from the investment (for example, over the past three years) minus the risk-free return over that period (for example, from a government bond), divided by the standard deviation of the portfolio’s excess return.  

Information ratio
The information ratio for an actively managed fund is virtually identical to the Sharpe ratio, but the risk-free rate of return used in the calculation is the figure that would be earned on a benchmark index. This benchmark is, in effect, what the asset manager might be expected to hold in the fund if he/she had no view on the market.

The ratio is calculated as the return from the portfolio (for example over the past three years) minus the benchmark return over that period, divided by the standard deviation of the portfolio’s excess return over that benchmark.  

Tracking error
If you are investing in a passive, or tracker fund, which aims to mimic the return on a broad market index by holding a smaller number of assets than there are in the index, you would want that fund to stick as closely as possible to the return on the underlying index. The tracking error for a passive fund reflects the difference between the return on the fund and the return on the underlying index – the lower the tracking error, the closer the passive fund is to its underlying index.

Gearing
Some investment trusts enhance returns by borrowing cash to invest in additional financial assets. At its simplest, gearing means borrowing money to buy more assets in the hope the company makes enough profit to pay back the debt and interest and leave something extra for shareholders. However, if the investment portfolio does not perform well, gearing can increase losses. The more an investment company gears, the higher the risk.

Dealing spreads
The dealing spread reflects the difference between the price at which you can buy a particular investment, and the price at which you can sell it. Ideally, you would want this spread to be as narrow as possible, so that when you finally come to sell an investment you do not sacrifice too much of your gains. The narrower the dealing spread, the more liquid an investment is considered to be.

Premium/discount to underlying (or ‘net’) asset value
The underlying (or net) asset value of a fund is the sum total of the value of all the underlying assets held by that fund, minus the value of all the liabilities (e.g. loans).

Where a fund will price itself at or close to this underlying asset value, an investment trust trades in the market wherever buyers and sellers choose to transact. This price may be higher than the net asset value of the fund (i.e. at a premium), or – more usually – it may trade below the net asset value of the fund (i.e. at a discount).  

A trust trading at a discount or premium to its net asset value can be a good or a bad thing depending on whether you want to buy or sell that trust. Some popular trusts trade at significant premiums, reflecting market confidence in the ability of the manager to carry on outperforming the market. Some trusts that hold illiquid assets trade at substantial discounts, reflecting the illiquidity of the underlying assets.

1  The exception is global bonds, where hedging allows you to take pure credit risk in GBP by eliminating the FX risk, thereby improving the protection characteristics of this particular asset in a broader customer portfolio