An outright return achieved irrespective of overall market direction. Whereas traditional investments typically measure their success in terms of whether they track or outperform a key market benchmark or index (relative returns), hedge funds and alternative investment strategies aim to achieve outright positive returns irrespective of whether asset prices or key market indices rise or fall (i.e. absolute returns rather than relative returns).
Widely considered to be a measure of the 'value added' by an investment manager. It is therefore regarded as a proxy for manager or strategy skill. Alpha is sometimes described as outperformance of a benchmark or the return generated by an investment independent of the market – what an investment would hypothetically achieve if the market return was zero. More specifically, alpha is sometimes described as the return of an investment less the risk-free interest rate, or the return of the portfolio less the return on the S&P 500 index or some other relevant benchmark index.
The terms 'alternative investment' and 'hedge fund' are often used interchangeably as hedge funds are an important and growing part of the alternative investment arena, which also includes private equity and debt, venture capital and real estate. In the field of asset management, the essential defining feature of alternative investments is the pursuit of absolute returns. That is:
- the quest to achieve a positive return regardless of whether asset prices are rising or falling
- freedom to trade in a wide range of assets and instruments employing a variety of styles and investment techniques in diverse markets
- reliance on the investment manager's skill and application of a clear investment process to exploit market inefficiencies and opportunities with identifiable and understandable causes and origins
The ability to use derivatives, arbitrage techniques and, importantly, short selling – selling assets that one does not own in the expectation of buying them back at a lower price – affords alternative investment managers rich possibilities to generate growth in falling, rising and unstable markets.
The technique of exploiting pricing anomalies between related securities within and between markets with the aim of producing positive returns independent of the direction of broad market prices. By establishing long positions in under-valued assets and short positions in over-valued assets, arbitrageurs aim to capture profit opportunities that arise from the changing price relationship between the assets concerned. Specific investment styles that apply arbitrage techniques include convertible bond arbitrage, fixed income arbitrage, statistical arbitrage and merger or risk arbitrage.
A measure of how sensitive an investment portfolio is to market movements. The sign of the beta (+/-) indicates whether, on average, the portfolio's returns move in line with the market (+), or in the opposite direction (-) to the market. If the beta of a portfolio relative to a benchmark index is equal to +1, then the returns on the portfolio follow those of the index. By definition, the beta of that benchmark index is +1. A portfolio with a beta greater than +1 tends to amplify the overall movements of the market, while a portfolio with a beta between 0 and +1 tends to move in the same direction as the market but not to the same extent. A portfolio with a beta of -1 tends to move in the opposite direction to the market.
An investment strategy whereby an investor considers companies based on their own merit rather than the sectors they are part of or the current economic climate. Opposite of Top-down.
The amount of investment capital that can be comfortably absorbed by a manager or strategy without a diminishing of returns. One useful indication of whether or not a manager or strategy faces capacity constraints is to analyse the degree to which they experience slippage [see Slippage] in the execution of their strategy or trades.
See Principal protection.
These securities package a risk of catastrophic events such as earthquakes or hurricanes into a bond. These bonds typically pay a spread over 3-month LIBOR, but if the insured event occurs the issuer is relieved of the obligation to pay the interest and/or principal amount.
Classical risk control
A fund which employs stringent risk controls which have to comply to fixed risk parameters.
Commission sharing is the process whereby Man Group companies recapture some of the commission paid to brokers as part of their normal course trading activities. Recaptured commissions are used to purchase substantive research, and services directly related to the execution of trades (“research and execution services”). Recaptured commission will only ever be used to pay for research and execution services where there is reasonable benefit to clients. Commission sharing is permitted by the UK Financial Conduct Authority, our lead regulator. Please contact us should you require more information on Commission Sharing.
Commodity Asset Class
A raw material or primary agricultural product that can be bought and sold, for example oil or wheat.
Commodity Trading Adviser (CTA)
The manager or adviser of a managed futures [see Managed futures] fund. The term reflects the fact that early futures markets [see Futures] were commodities-based and were set up to enable producers and buyers to hedge against possible price movements in the underlying asset.
Compound Annual Rate of Return (CARR)
The compounded 'growth' of an investment that has been achieved each year to enable the initial price to grow to the latest selected price over a particular time period.
Constant Proportion Portfolio Insurance (CPPI)
A strategy that synthetically reproduces the pay-out of a put or call option through dynamically adjusting the delta hedge of the underlying asset. Unlike a conventional option, the investment exposure (or participation) of the underlying asset will change over the life of the structure.
An index or similar factor that fund managers use to limit or constrain how they construct a fund’s portfolio.
A bond issued by a company that has a set maturity date and pays interest in the form of a coupon. It has features of both a bond and stock and its valuation reflects both types of investments. It gives the holder the option to convert the bond into a specific number of shares of the issuing company – in other words, it has an 'embedded option'.
An index or similar factor against which a fund manager invites investors to compare a fund’s performance.
A measure of the interdependence or strength of the relationship between two investments. A correlation of 1 means that the two investments are perfectly synchronised, while a correlation of -1 implies that they move in symmetrically opposite directions.
An agreement permitting a buyer to receive something of value now, with an obligation to repay this at some date in the future, generally with interest.
The specific day on which investors can subscribe (buy) or redeem (sell) their holding in a product, as detailed in the relevant product legal document. The dealing day can be daily, weekly, monthly or quarterly, depending on product valuation frequency.
The sensitivity of an option price to moves in the price of the underlying asset.
Financial contracts such as futures [see Futures], options and various securities that offer 'synthetic' access to an underlying asset such as a commodity, stock market or fixed income security. The price movements of a derivative generally follow the price movements of the underlying asset but derivatives generally require only small amounts of capital (margin) to gain exposure to the underlying asset.
By employing long/ short investing and hedging strategies the investment may be able to provide protection against severe market drawdowns.
An investment is said to be in a drawdown when its price falls below its last peak [see Net new highs]. The drawdown is the percentage drop in the price of an investment from its last peak price. The period between the peak level and the trough is called the length of the drawdown, and the period between the trough and the recapturing of the peak is called the recovery. The worst or maximum drawdown represents the greatest peak to trough decline over the life of an investment.
See Portfolio efficient frontier
An ownership right representing an interest in a company.
Profits from taking up long and offsetting short positions in undervalued and overvalued stocks with a fixed or variable underlying net long or short exposure.
Fixed Income Asset Class
A security that pays a specific level of interest. An example of a fixed income security is a bond issued by a government or large company.
A forward contract is a customised contract between two counterparties to buy or sell a specific asset on a future date at an agreed price. As opposed to stocks and bonds, a forward contract is a derivative instrument, the value of which depends on an underlying asset. Unlike standard futures contracts, forward contracts are not traded on a centralised exchange and are highly customisable.
The underlying proposition of fundamental analysis is that there is a basic intrinsic value for the aggregate stock market, various industries or individual securities and that these depend on underlying economic factors. The identification and analysis of relevant variables combined with the ability to quantify the future value of these variables are key to achieving superior investment results. A wide range of financial information is evaluated in fundamental analysis, including such income statement data as sales, operating costs, pre-tax profit margin, net profit margin, return on equity, cash flow, and earnings per share.
Fundamental analysis contrasts with technical analysis which contends that the prices for individual securities and the overall value of the market tend to move in trends that persist.
A future is a derivative instrument [see Derivatives] that involves a contract to buy or sell an asset (stock index, commodity, currency, fixed income or other security) for delivery at a future date at a specific price.
See Net new highs
The level of return (often the risk-free interest rate) which investment managers sometimes stipulate net new highs must exceed in order for performance fees to be charged.
Hedge fund products which pay an income stream are a type of structured product which continues to grow in popularity. The benefit of this type of structure is that it provides a transparent payoff profile through regular (for example semi-annual) defined income payments for a fixed term.
Industry loss warranties
An option contract on industry-wide insurance claims that exceeds a predefined amount (e.g. hurricane Katrina, $ 40 billion).
An investment region is the primary geographic region a fund is focused on. For example, an emerging markets fund will invest exclusively in emerging economies, such as Brazil, India, Mexico and Russia.
Typical investment regions include
- Emerging Markets
- United Kingdom
- United States
One refers to an `initial public offering (IPO)` when a private company sells shares of its stock to the general public for the first time via a securities exchange. Through this process, a private company transforms into a public company.
Leverage and gearing effectively mean the same thing: the process or effect of ‘gearing up’ or magnifying exposure to an investment strategy, manager or asset. Leverage can be achieved by borrowing capital or using derivatives. A leveraged investment is subject to a multiplied effect regarding the profit or loss that results from a comparatively small change in price. Thus leverage offers the opportunity to achieve enhanced returns, but at the same time typically involves greater risk and can result in a loss that is proportionally greater than the amount invested.
A relative term to describe the speed at which an asset or assets can be converted into cash (liquidated) and vice versa. Common terms include
- Other - such as quarterly or ad hoc.
An interval during which an investment may not be sold.
Buying securities that are considered undervalued in the expectation that they will rise in value.
Profits from taking long and offsetting short positions in undervalued and overvalued securities with a fixed or variable underlying net long or short exposure.
A factor that is relevant to a broad economy at a regional or national level. For example, such factors include economic output, unemployment, inflation, savings and investment.
The segment of the alternative investment industry which actively trades and manages futures instruments [see Futures]. The advisers that focus their asset management efforts on futures are known as CTAs [see Commodity Trading Adviser]. They invest on both the long and short side of the market and usually employ quantitative or technical analysis [see Quantitative analysis] and systematic investment processes.
The amount of capital that has to be deposited as collateral in order to gain full exposure to an asset.
Denotes an approach to investment where the emphasis is on the value of securities relative to each other and the use of arbitrage techniques [see Arbitrage], rather than market direction forecasting. By emphasising the relative value of securities and the exploitation of pricing anomalies between related securities, practitioners of market neutral approaches aim to generate profits regardless of the overall direction of broad market prices. Market neutrality is generally achieved by offsetting, or hedging, long and short positions or maintaining balanced exposure in the market. The term market neutral can be applied with some justification to the majority of alternative investment styles because of their ability to capitalise on both upward and downward price moves or to profit in a wide range of market environments.
Monte Carlo simulation
A mathematical technique used to model the price characteristics of an investment structure based on random simulations of the underlying assets or variables that affect the price of that investment. In the context of the modeling carried out at Man, the analysis involves constructing multiple NAV paths for a product, net of all appropriate fees and interest, using random samples of gross monthly returns. The price characteristics that can be modeled using this powerful technique are known as 'path-dependent' characteristics, such as risk, return, and drawdowns, which depend on NAV movements over the life of an investment structure.
The speed of price change over a period of time. Momentum-based investment styles, notably trend following approaches, aim to capitalise on the acceleration in directional price movements, be they upward or downward.
A widely used composite index of capital-weighted stocks developed by Morgan Stanley Capital International, which can act as a proxy for world stocks when assessing the relative performance of any portfolio with global asset exposure.
An investment that combines a number of asset classes, for example stocks and bonds.
Net new highs
A net new high is reached when the net asset value of an investment exceeds the previous peak level in the net asset value (also known as the 'high watermark'). Performance fees [see Performance fee] are levied on net new highs.
An investment product with no defined lifespan. New units (e.g. shares, bonds, units, notes) are created or dissolved as required. Investors can subscribe (buy) or redeem (sell) these units at the prevailing net asset value per unit in accordance with the details set out in the relevant product prospectus.
A derivative instrument [see Derivatives] that gives the holder the right, without obligation, to buy (call) or sell (put) a security or asset at a fixed price within a specified period or at a particular future date.
Portfolio efficient frontier
By plotting the intersection of risk and reward for different investments or weightings of assets, one can generate a risk/reward curve or 'frontier' for those investments. The efficient frontier is the point on such a curve where an investment combination delivers the most favorable balance of risk and reward.
An arrangement or mechanism built into an investment product whereby investors are assured that their initial investment is secure and that this amount will at the very least be returned to them when such a product reaches its maturity date. Principal protection features can take a variety of forms, including capital guarantees provided by banks.
In the context of a long/short equity approach, a prime broker acts as the intermediary between the two counterparties involved in short selling by matching a stock borrower (equity long/short manager) with a stock lender (typically a pension fund or large institution). The prime broker also collects margin payments from short sellers should the market price of the stock move against them.
A representation of a track record [see Track record] that is developed to show the effect on actual performance of intended or potential adjustments for different fee structures, portfolio allocations or other variations in the investment structure upon which the original track record is based. It is important to note that a pro forma is based on actual trading results and differs from a simulation, which models the hypothetical performance of a portfolio or investment approach that has yet to be applied or implemented in actual trading.
Analysis that uses subjective judgment to evaluate securities based on non-financial information such as management expertise, cyclicality of industry, strength of research and development, labor relations and depth of operational infrastructure.
Qualitative analysis evaluates important factors that cannot be precisely measured rather than the actual financial data about a company.
Quantitative analysis uses statistical techniques to develop investment models using key financial ratios and economic indicators. The use of objective data facilitates the comparison of a large universe of securities to identify a select range of potential investment possibilities.
Quantitative analysis deals with measurable factors in contrast to qualitative considerations such as the character of management.
Insurance for insurance companies. Coverage is provided on an indemnity basis, meaning reinsurers are liable for catastrophe claims made by the insurer’s policyholders. Direct reinsurance is typically a syndicated markets and coverage is purchased in ‘layers’ or tranches.
Retrocessional reinsurance (retro)
Reinsurance for reinsurance companies to protect themselves against catastrophic events. Traditional retro is similar to direct reinsurance in that the coverage is provided on an indemnity basis, unlike industry loss warranties which are triggered by an index of industry claims.
Risk relative to return – the return achieved per unit of risk or the risk associated with a particular level of reward, typically represented by the Sharpe ratio [see Sharpe ratio]. Improving the risk-adjusted return depends either on increasing returns and maintaining the level of risk or maintaining the level of returns and lowering the associated risk.
A measure of risk-adjusted performance [see Risk-adjusted performance] that indicates the level of excess return per unit of risk. In the calculation of Sharpe ratio, excess return is the return over and above the short-term risk free rate of return and this figure is divided by the risk, which is represented by the annualized volatility or standard deviation [see Volatility and Standard deviation]. The greater the Sharpe ratio the greater the risk-adjusted return.
Short selling / Short investments
A trading technique whereby an investment manager arranges to borrow stock from a stock lender with a view to selling it and buying it back at a lower price in the future.
The difference between the sample or target price for buying or selling an asset and the actual price at which the transaction takes place.
A measure of risk-adjusted performance [see Risk-adjusted performance] that indicates the level of excess return per unit of downside risk. It differs from the Sharpe ratio [see Sharpe ratio] in that it recognizes investors' preference for upside ('good') over downside ('bad') volatility and uses a measure of 'bad' volatility as provided by semi-deviation – the annualized standard deviation of the returns that fall below a target return, say the risk free rate.
A widely used measurement of risk, usually used to represent volatility [see Volatility], derived by calculating the square root of the variance of the returns of an investment from their mean.
The particular investment process employed by a manager in the application of an investment style [see Style].
Typically provides principal protection [see Principal protection], invests across a range of styles and managers, provides increased investment exposure [see Leverage] and requires a high level of structuring expertise with respect to blending investment approaches, financing, liquidity and risk management.
An individual hedge fund’s strategy/investment approach can generally be categorized into one of five main styles: equity hedge, event driven, global macro, managed futures or relative value. Practitioners of a particular style will have their own investment process or strategy with unique distinguishing features and techniques.
An index or similar factor that is part of a target a fund manager has set for a fund’s performance to match or exceed (including anything used for performance fee calculation).
The basic premise of technical analysis is that prices move in trends that persist and this characteristic can be used to achieve superior returns. Technical analysis often uses computer programmes to examine market data such as prices and volume of trading to make an estimate of future price trends and an investment decision.
Unlike fundamental analysis, technical analysis is not concerned with the financial position of a company.
The total percentage return of an investment over a specified period, calculated by expressing the difference between the investment’s initial price and final price as a percentage of the initial price.
Trading Adviser Report (TAR)
A performance report produced by an investment manager that is made available, usually on a monthly basis, to clients with holdings in a particular product. The report details the change in net asset value of a product and explains performance in light of market conditions as well as any relevant portfolio changes and developments.
The actual performance of an investment since inception, usually represented by audited monthly returns, net of fees.
The general direction of the market, such as a relatively persistent upward or downward price movement over a period, sometimes represented by the mean of price changes in that period.
An investment strategy whereby an investor finds the best sectors to invest in and then searches for the best companies within those sectors or industries. Opposite of Bottom-up.
UCITS, or 'Undertakings for Collective Investment in Transferable Securities', can refer to funds which comply with a set of European directives which aim to establish a single market for financial services within the European Union. The funds are designed to offer investors low minimum investments, liquidity, transparency and onshore regulation.
Unit / new unit
A generic term used to describe the 'instrument' (share, bond, unit, note) which is issued by a product. Investors subscribe to or invest in a product by buying units and redeem their holding by selling units at the prevailing net asset value per unit, as detailed in the relevant legal document.
A widely used risk measurement technique that calculates (at a pre-specified level of probability) the loss that would be experienced in a day or some other pre-specified time horizon in the event of an increase in volatility or an adverse correlated move in market prices, assets or the investments making up a portfolio. At Man, the proprietary measure of VAR is also known as Total Portfolio Risk (TPR).
Volatility is the measurement of risk used most often in the investment industry. It measures how variable price changes are in relation to the price trend for an investment. It is important to note that volatility says nothing about the direction of the trend itself. Expressed in slightly more technical terms, volatility is a measure of how much a set of returns for an investment deviates from the price trend or mean of that investment. It is usually calculated as 'standard deviation' [see Standard deviation] and expressed as 'annualised volatility' – the standard deviation on a yearly basis.
Zero coupon bond
A bond bought at a discount from its face value which offers the entire payment at the time of maturity. Unlike other bonds, it does not make periodic interest payments, hence the name ‘zero coupon bond’.