Accumulation is when income such as dividends and interest is reinvested in an ETF.
An investment fund whose securities portfolio is actively picked, weighted, monitored and reviewed by a fund manager, who adjusts it in line with the market situation. Active funds usually have a higher total expense ratio than passive funds because of the higher research, personnel and administration costs involved.
Alpha represents the relative active return on an investment; in other words, the performance of an actively managed investment against a suitable benchmark. Alpha is used to gauge the outperformance or underperformance of an investment such as a fund relative to the benchmark.
Exploiting price differences by buying and selling securities on various exchanges simultaneously. Theoretically a way of making risk-free gains.
Ask refers to the price at which sellers are prepared to sell their shares.
An asset class is a group of investment instruments such as shares (equities), bonds (fixed income) or commodities.
A situation where the upside potential is bigger than the downside risk. Asymmetric payoff profiles make it possible to create structures such as capital protection or return optimis
Abbreviation for assets under management: an ETF’s assets under management represent the market value of all its outstanding shares or units.
100 basis points correspond to one per cent. For example, 35 basis points correspond to 0.35 per cent.
The term benchmark refers to a reference index or reference value used to compare the performance of an individual’s investments or an investment fund. ETFs use the underlying index as their benchmark.
Beta is a measure of sensitivity, usually between an asset and the “market” or a representative market index. If an asset has a beta greater than 1, for example, it can be expected to gain more than the market if there is a gain in the overall market.
The bid is the price at which sellers are prepared to sell securities.
Refers to the most heavily traded, more highly capitalised stocks on an exchange.
A debt investment that usually pays fixed interest over the entire term.
A fee paid to a bank or broker for executing a stock exchange transaction.
An investment strategy involving holding securities for a long period of time.
Swiss Federal Act on Collective Investment Schemes. The most recent version of CISA has been in force since 1 January 2007. It is designed to protect investors and ensure transparency and the proper functioning of the Swiss fund market. Amendments contained in the most recent legislation cover areas such as new legal forms and the use of derivatives.
A phenomenon that arises when a fund’s assets include cash. When the markets are on their way up, cash causes the fund to underperform the benchmark; when the markets are on their way down, cash results in a relative outperformance.
A note or certificate from an issuer embodying an investor’s right to participate in the price development of specific securities or other financial instruments.
In a core-satellite strategy a large portion of assets is invested in well diversified index investments. This core is surrounded by satellites, higher-return investments designed to generate alpha.
A figure between 1 and 1 describing the relationship between two variables. In the context of financial instruments, a positive figure points to frequent price movements in the same direction, while a negative correlation points to movements in the opposite direction.
Also default risk. The risk that a counterparty will not meet its obligations and will thus cause financial damage to another contracting party.
The denomination in which units of an ETF can be subscribed or redeemed. In some cases a creation unit can consist of up to 50,000 units. By contrast with conventional investment funds, ETFs do not permit investment in individual units.
The creation/redemption mechanism involves exchanging equity baskets for fund units. To track the fund’s underlying (index), the market maker puts together a basket of equities (exactly corresponding to an index such as the SMI). In return, the market maker receives from the issuer the exact same value in fund units, which can then be resold on the market (creation). By the same token the market maker can return units to the fund management company in return for shares (redemption).
The risk arising from a shift in the value of one currency relative to another.
Financial instruments whose price develops in line with fluctuations in the price or expected price of other securities. Derivatives can be constructed in such a way that they magnify changes in the price of the underlying securities. Examples include futures, options, swaps and similar products.
In fund terms, distribution is the opposite of accumulation. It refers to funds that on a specified date distribute regular income such as interest and dividends to unitholders in cash.
Also risk diversification. Diversifying a portfolio among different asset classes or assets. The aim is to achieve as a high a return as possible while keeping the risk of the portfolio as low as possible.
The dividend is the portion of a company’s distributed earnings paid to the holder of each share. The annual general meeting of shareholders decides the amount of the dividend.
The average period for which capital is tied up in a bond, also used as a measure of sensitivity to small changes in interest rates. Duration is commonly calculated as a modified or Macaulay duration.
Equal weight indices are smart beta indices where all stocks are given the same weight. In an index of 100 stocks, for example, each stock would be given a weighting of 1 per cent. This is a way of improving diversification by avoiding concentration on a small number of large cap stocks. This method increases the importance of small and mid caps, which in turn enhances the risk/return profile.
Exchange traded commodities (ETCs)
ETCs track a commodities index one to one, and are characterised by particularly low management fees. In legal terms ETCs are comparable with certificates, because unlike traditional funds they do not constitute a segregated pool of assets. This means that if the issuer of an ETC files for bankruptcy, the assets and rights will not be segregated in favour of the investors.
Exchange traded funds (ETFs)
ETFs are passively managed index funds traded on the stock exchange. There is no limit on the term of the ETF, and like conventional investment funds they are a segregated pool of assets. ETFs track an underlying index of stocks, bonds, money market investments, real estate, hedge funds, currencies or commodities more or less exactly. They are traded like shares on the stock exchange. The advantages of ETFs are much lower costs than conventional funds, and transparency.
The economist Eugene Fama formulated the efficient market hypothesis. This assumes that markets are efficient; in other words, that they always reflect reality. As a student he observed that strategies from the past often brought little success in the future. Later in his PhD thesis he demonstrated that short-term price changes on financial markets are not predictable. Despite this, prices soon return to reflect all publicly available information. Together with Kenneth French he also developed the three factor model, whereby stock returns can be explained in terms of the market, value and size. This means it is possible to achieve above-average returns by focusing on small caps. These insights also inform smart beta indices. In 2013 Fama – together with Robert J. Shiller and Lars Peter Hansen – was awarded the Nobel Prize in Economic Sciences.
The currency in which the assets managed in an ETF are valued. The fund currency does not necessarily correspond to the currency in which the ETF is traded on the exchange.
Fundamental index (also fundamentally-weighted index)
These include so-called smart beta indices. In this type of index, stocks are weighted by economic fundamental factors such as earnings growth, price to earnings, book value or dividend yield. They are designed to reflect the real economy more accurately. This approach weights value stocks more heavily.
A basket of securities put together to create a measure representing a market or a defined part of the market. There are different methods for choosing and weighting the securities in an index.
Regular adjustment to an index on the basis of the rules set by the index provider.
Index tracking means mirroring the development of an index as exactly as possible. To do so, fund providers can hold all the stocks held in the index themselves, or they can even use derivatives to replicate the index.
Institutions such as pension funds, insurers and investment companies that engage in large-scale trading on the money and capital markets.
The issuer of securities such as ETFs, structured products or bonds.
iNAV (indicative net asset value)
iNAV (indicative net asset value) represents the net asset value of an ETF unit. This corresponds to the actual value of the fund units with a basket underlying. Calculated on an ongoing basis, it is a way for investors to track the difference between the prices quoted by the market maker and the net asset value.
Leverage usually refers to the use of borrowed money. Generally the idea behind leverage is to borrow funds to be able to invest more than would be possible with the money available.
In stock exchange jargon, a liquid market is one where securities can be easily bought and sold at any time. From a risk management point of view, permanent tradability is essential to be able to respond efficiently to any market situation.
Buying a security in the expectation of rising prices is referred to as taking a long position or going long (as opposed to taking a short position or going short).
Low volatility indices endeavour to reduce the risk, primarily by focusing on volatility. Indices of this type give the greatest weight to securities with the lowest historical price fluctuations. Similar products are known as minimum variance ETFs.
A fee charged by the issuer for portfolio management and administration, expressed as a fixed percentage of the net assets of the fund. The management fee is automatically charged to the fund’s assets on a regular basis.
Market capitalisation (market cap)
The components of most indices are weighted by market capitalisation, in other words the stock market value of the company. Market cap is calculated by multiplying the number of outstanding shares by the current share price. The disadvantage of this approach is that highly valued stocks are weighted more heavily. Stocks that performed well in the past are given a greater share of the index. An alternative is smart beta indices.
Market makers are official members of a stock exchange who ensure the necessary market liquidity by quoting binding ask and bid prices for certain securities, for example ETFs, and trading for their own account and at their own risk. In most cases market makers are banks or brokers. Their remuneration for this service is the spread between the bid and ask prices on the securities they trade.
Harry M. Markowitz formulated his portfolio theory in the 1950s, and was awarded the Nobel Prize in Economic Sciences in 1990. His work revolves around the search for the optimum risk/return tradeoff. Since different asset classes correlate, Markowitz recommended picking assets whose returns develop as independently as possible from one another. To reduce the risk of an investment he focused on volatility. The more the value of an asset fluctuates, the greater the risk. His most important insight was that the risks of a portfolio can be minimised by means of diversification – in other words by skilfully picking and weighting assets.
According to Harry M. Markowitz’s mean-variance portfolio theory, an investor can use diversification to reduce the risk for a given return – or, by the same token, to increase the expected returns for a given risk. These decisions are made on the basis of expected values and statistical distributions. When analysing securities, Markowitz took account of variance and covariance in addition to returns.
The Markets in Financial Instruments Directive is an EU regulation designed to harmonise the market for financial instruments. The main goals are investor protection, greater competition and improved market access for all investors. This includes best execution and specific documentation requirements.
There are various ways of reducing the risk of a portfolio (see low volatility). Minimum variance strategies, developed on the basis of the insights of Harry M. Markowitz, aim to reduce the overall risk of a portfolio by minimising volatility. To do this, the covariance matrix of individual stock returns is estimated. Detailed estimates are made of the correlations and volatility of the securities. Limits are also imposed on the weighting of individual stocks or sectors. There are slight differences between the selection procedures used by different ETFs.
An ETF usually trades at prices close to the NAV (net asset value). Calculated by the fund provider on a daily basis, the NAV represents the value of the portfolio at a defined point in time. More specifically, the net asset value refers to the redemption price of a fund unit. It is calculated on the basis of the current value of the securities, other assets and cash held by the fund, minus its liabilities, divided by the number of fund units in circulation.
The total value of all the assets held in a fund. The net assets of a securities fund comprise equities and/or fixed income securities, cash reserves, and other assets.
A fund designed to replicate an index one for one and track its performance. ETFs are a type of passively managed fund.
Performance is the term used for the development of an investment or a whole portfolio of investments.
In physical replication the performance of the index being tracked is achieved by holding all or a selection of the securities held in the index.
Portfolio refers to an investor’s entire securities holdings. These can include shares, bonds, ETFs, options, etc.
Portfolio selection theory
This is a theory developed by Harry M. Markowitz. The basic assumption is that markets are efficient; in other words, that prices contain all the available information. For Markowitz this means the efficiency of a portfolio can be improved by means of diversification; in other words, the portfolio will be better if it is spread over different types of investment in terms of risk and return. Different criteria can be used to assess the relationship between risk and return: the expected return of the asset, the risk associated with each asset, and the correlations between them.
A price index is calculated exclusively on the basis of the market prices of the stocks it contains. By contrast with a total return index, income paid out from the securities is not reinvested in the index.
Also issuing market. The market that deals with the issuing of new securities.
The aim of sampling is to replicate the performance of an index as exactly as possible by holding part of the securities held in the index. Various mathematical models are used to achieve this.
1) Broad definition: a certificate embodying private rights whose exercise is essentially tied to possession of the certificate. 2) Narrower definition: fungible (fully exchangeable) certificates that either embody claims on an equity interest or debt or grant unconditional or conditional entitlement to earnings.
Segregated pool of assets
A pool of assets strictly separated from the company assets. Segregated assets are not included in the value of a fund company; they are administered by a custodian bank and are thus segregated in the event that the issuer files for bankruptcy.
Selling a security in the expectation of falling prices is referred to as taking a short position or going short.
A speculative sale of securities, commodities, currencies, options or other exchange tradeable financial products. The securities, etc., are sold even though the seller does not possess them, with the intention of buying them more cheaply at a later date. The seller speculates on the difference between a higher selling price and a lower repurchase price.
Smart beta refers to intelligent indices, although there is no uniform definition. The term “strategic beta” would make more sense. Here barometers are weighted by alternative criteria such as volatility or dividend payments rather than by market capitalisation and free float. The advantage for investors is a better risk/return profile.
The difference between bid and ask price. Also bid-ask spread.
Subscription fee (also front-end load or initial sales charge)
Fee paid by investors acquiring units in active securities funds to cover the costs of issuing units. The fee can vary from 1 to 5 per cent depending on the type of fund. Exchange traded funds do not charge a subscription fee.
An agreement between two parties to exchange cash flows in accordance with certain agreed terms. For example they might exchange the return of a portfolio for the return of an index.
Swaps come in different forms. Synthetic ETFs often use total return swaps (unfunded) or fully-funded swaps.
Symmetric payoff is when a financial instrument (for example an ETF) develops in line with its underlying.
In this form of replication the securities in the fund (ETF) do not have to correspond to the securities in the index. The performance of the index is tracked by using derivative instruments such as swaps. This method of replication also allows the tracking of indices that cannot be replicated physically.
The total expense ratio (TER) of an ETF gives an indication of all the costs accruing every year. The TER includes administration and custodian fees, but does not include transaction costs.
In addition to tracking changes in the prices of the securities held in the index, a total return index assumes that cash distributions are reinvested back into the index. In recent years dividends in particular have become increasingly important, as many companies are generating better returns for their shareholders by paying a higher dividend or paying back capital.
The tracking error measures the standard deviation of an ETF’s return from the benchmark return. The higher the tracking error, the less closely the ETF follows its reference index. This difference is the result of costs for buying and selling and the annual management fee. The tracking error is also influenced by the time lag in the payment of dividends.
Transaction costs are costs such as bank commissions and brokerage incurred on the sale and purchase of securities.