A cynic's A to Z guide to the investment industry, where getting to grips with the terminology requires a degree in its own right
Nobody could have guessed that the financial services industry, which is dominated by finance, laws, bills and taxation, could ever have become so convoluted.
Nowhere can this be arbitraged for greater gain than here, where the potential for huge rewards attracts the smartest, most dedicated and greediest.
And nowhere can resulting misunderstandings lead to a greater loss than among investors who want to believe the hype at the top, while ignoring disclaimers at the bottom.
Language can be hijacked if enough resources are thrown at it often enough, and the financial services industry can devote such resources to retail marketing, public relations, media exposure and investor presentations. Growth shares that shrink in value are just the most obvious example.
Words can be used as disguise and conflicts of interest can be masked with pseudo-scientific jargon. In the investment industry, risk is the classic case. For investors, it means the risk of capital loss, but for professionals it means career risk.
The following glossary is what could be described as a cynic's guide to investment jargon.
Alpha - The amount by which a fund's performance exceeds its benchmark - what you pay the fund manager to achieve. He claims superiority at picking the right stocks, but statistics show it is usually superiority at picking the right kinds of stocks at the right time.
Beta - also known as volatility. Beta has migrated from simply describing two-way fluctuations in value to including everything beyond the fund manager's control. This includes where investors rely on a fund manager to be uniquely well-qualified and adept at predicting which way the market moves next.
Cautiously Optimistic - the sell-side's default recommendation. It promises profits, but appears conservative. It is not so optimistic as to risk being proved wildly wrong and has the same usefulness as any Delphic oracle. It is highly likely to be right to some extent at some time, but does not specify when or by how much.
Defensive - a high exposure to bonds or blue chip shares. This suggests little risk of capital loss, but if investors' fear drives the prices of defensive investments too high, such losses become most likely when market fashions change. Long-term British Government bonds currently fit this description.
Free - meaning no charge for this service. This is the most powerful four-letter word in marketing. All too often it translates into a different four letter word, when investors learn much later they were not smart enough to take the bait without swallowing the hook. In financial services the term usually relates to free money-losing advice.
Guaranteed - 100% results. Questions you should ask include capital and income? By whom? how long? And many more based on what is buried in the small print disclaimer. All investments are bets, and 'sure things' are either too good to be true or opportunity costs.
Hedge fund - funds that earn prices on the spread between buying and selling similar investments, independent of market direction. Typically long high-risk and short low-risk holdings, both sides can lose money in liquidity crises.
Junk bond - low-rated corporate bonds. People unaware buy them when the yield on quality bonds is low. Unfortunately, if issuers go bust they have the downside but not the upside of equities. Confusingly, nobody publicly calls any bond until it is too late.
Krugerrand - a South African coin containing one ounce of gold, this is the only investment that governments cannot debase, devalue, dishonour, expropriate, tax or prevent one taking out of the country, because it is small enough to fit in a wallet.
Leverage buyout - a take-over bid funded by debt, otherwise known as private equity. Such take-overs are usually financed by loans taken out against the company's own assets, they are bids to buy someone's shares with their own money. These are sure signs of undervaluation both for that stock in particular and often also that stock market in general.
Market timing - short-term dealings in open-ended funds, now a term of market abuse, encouraged by managers who prefer buy-and-hold investors, but in previous decades, a fine long-term way of beating cyclical markets. Indeed, it was most successful in the 1960s and 1970s, and may be again, if the secular bull market is over.
Nuclear waste - the lowest quality component, when a bond is broken up. These are sold by smart investment bankers using smoke and mirrors. They are bought for short-term gain (and long-term loss) by those who do not know better or do not expect to be around for long.
Offshore - an investment legally based in a tax haven. While such tax dodges may well be perfectly legal, they are likely to be money-losing propositions because investors become so enraptured by the tax savings that they are blind to fees, mis-management, over-pricing or poor market timing.
Past performance - the most popular single measure for picking funds, derided by the Financial Services Authority. Fund managers have been bullied into disclaimers that past performance is no guide to the future. However, while it is true there are no guarantees, it remains the best guide to future market performance, until human behaviour changes.
Quantitative - an investment process based entirely on objective quantifiable data, while improving the odds, no investment system works all the time, nor can it, otherwise everyone would use it. Typically, systems fail when they have become most popular and managers get sacked just before they come back into fashion.
Random walk - the theory that markets are efficient because everything relevant is already discounted. Another theory, behavioural finance, states the opposite and the performance of retail investors confirms it. The market may be a random walk for many, but that has not been my experience, nor of others who study the flow of funds.
Stockpicking - otherwise known as a bottom-up investment process. It is an endurance competition in meeting record numbers of company management and is what fund managers want to be paid to do. Sadly, it is largely pointless because most outperformance can be attributed to picking the right investment style, sector, country or cash position. It is the big picture that makes the difference.
Tracking error - the amount by which a fund's performance differs from its benchmark. This implies conformity is good, possibly the case for keeping managers' jobs, but all it does for investors is guarantee mediocrity. Managers who lose less in bear markets or make more in bull markets have high tracking errors. That is good, not bad.
Unit price - the price per unit in an open-ended fund. Performance of the average unit is not the same as the average unit-holder's performance, which is generally worse because of the buy-high, sell-low strategy of gullible investors. Advisers who deliver apparently average portfolio performance are in fact well above average, it is just that the industry lacks any incentive for showing by how much.
Volatility - the amount by which an investment value fluctuates in both directions. It typically peaks at market troughs, so commentators' belief that the market hates volatility is either trite or nonsense. It is also often confused with risk as it is easily measurable and distracts from nebulous thoughts of overvaluation or adverse trends, which are the real risks of capital loss.
War loan - a perpetual UK gilt-edged security. Marketed for patriotism, it earned itself a bad name for robbing savers through inflation. However, its uniqueness also subsequently made it a rarity in fixed-interest markets, a two-way bet that has generated a total return of 5,500% over the past three decades.
The X factor - that special proprietary ingredient that justifies premium pricing. With hindsight, it either proves to be superior marketing, or ultimately copyable, so produces performance that is nothing special, except for those with the courage to be early adopters, which is generally before it becomes widely marketed.
Yield - the current return on an investment. The distinction between short-term income or long-term capital growth has become misleading ever since the growth stock bubble burst, as high-yielding value shares subsequently outperformed and growth stocks decided to pay dividends. Since dividends are only the part of earnings that management chooses to pay out, prudent investors should focus on P/E ratios and growth rates.
Zeros - discounted bonds that accumulate to maturity rather than paying interest. Sold for deferring cash outlay and bought as safe tax-efficient investments, many of these end up worth nothing. This can happen if highly-geared or cash-strapped issuers go bust, wiping out all their shareholders equity and more.
Fund managers and investors have very different ideas of what risk means
Leveraged buyouts are often a sign the stock market is undervaluing shares
Volatility is not the same as risk and is not necessarily a bad thing
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