ETF GLOSSARY

Financial professionals can assist their clients with a better understanding of ETFs by helping them navigate the industry terminology.

ACTIVE INVESTING

These are investments which are ‘actively managed’ by a financial professional to beat the performance of an index or benchmark. Managed funds are typically ‘active’ investments where investors pay for the skill of the manager to beat the market.

ALPHA

The amount by which an investment beats or outperforms an index or benchmark, typically applied to managed funds or other ‘active’ investments.

ASSET ALLOCATION

Asset allocation is one of the single most important ways of managing the risk and reward of the overall investment. By spreading a portfolio across different assets, such as stocks, bonds, property and cash, different levels of risk and potential return can be achieved.

How assets are allocated will depend on the clients’ objectives. For example, if a client is seeking high short-term gains, this will mean the financial advisor will need to take more risk than if seeking steady returns over a long time.

BETA

This is the return of an investment relative to a market index. An investment with a beta of 1 moves up and down the same amount as the market. Most ETFs are ‘beta’ funds, designed to track the return of an index.

DIVERSIFICATION

Diversification, while similar in concept to asset allocation, goes further in balancing risk and return. Asset allocation gives portfolios some basic diversification by determining how much of it to invest in stocks, bonds, property etc. Deciding which specific stocks and bonds to invest in and by how much gives further diversification.

The net result is if one of the investments is not tracking well, having a diversified portfolio potentially means the gains from other investments may offset this. Diversification can be a way to seek to build an efficient investment portfolio that meets both a client’s appetite for risk and return.

HIGH YIELD BONDS

Many investors have some level of high yield bonds in their portfolio as they offer attractive potential for income. A high yield bond is debt often issued by a company with a low credit rating. The yield is high as investors can expect a potentially higher return to compensate for the greater risk.

INDEX

An index is a basket of securities representing a whole market or a submarket. It tracks the performance of this market and serves as a benchmark for investors or fund managers. A common index is the S&P 500 index.

LIQUIDITY

Liquidity is how quickly an asset can be converted into cash. Basically, it is how the asset or security can be bought or sold without affecting the asset’s price. Knowing how ‘liquid’ the asset is will help determine where to invest.

The higher the liquidity, the easier and more cost-efficient it will be to trade. If it has low liquidity, this could indicate higher trading costs and potential difficultly in buying or selling.

MINIMUM VOLATILITY

Minimum volatility is an investment approach that aims to do as it says—minimize volatility. Essentially, it is a strategy that seeks to minimize the impact of market ups and downs.

Tools under this strategy such as minimum volatility ETFs can help ensure minimal impact from changes in say interest rates, currency shifts, or rapid ups and downs in stock prices. Financial professionals who implement minimum volatility strategies aim to give investors close to market return but with minimum risk.

PHYSICAL ETF

A physical ETF tracks the target index by holding all, or some, of the underlying assets of the index. For example, an S&P 500 ETF will consist of either all 500 companies in the S&P 500 index, or at least a representative sample of that basket of stocks.

Physical ETFs are more commonly available, and are usually lower risk compared to, for example, synthetic ETFs.

SYNTHETIC ETF

A synthetic ETF does not invest in assets directly but are ideal for access to traditionally out of reach assets or hard to access commodities, like crude oil.

For example, instead of owning barrels of crude oil, a synthetic ETF tracking oil will hold a series of oil futures contracts. These agreements are set up with a third party, often an investment bank, who promises to pay back an agreed level of return when oil reaches a certain price.

Synthetic ETFs offer potentially higher returns than buying stocks or other vehicles that involve directly holding the asset but they often come with greater risk.

YIELD

The return from an investment. It is usually a percentage of the investment amount. For example, an ETF priced at $100 that paid a $5 dividend, has a historic yield of 5%.