Terminology for Funds
AUM or Assets under management is the total market value of the investments that a fund (or an entity in general) manages on behalf of clients. It is sometimes known as Funds Under Management (FUM).
The NAV or Net Asset Value is the net value of a fund and is calculated as the total value of the fund’s assets minus the total value of its liabilities. Usually, the NAV represents the per-share price of the fund on a specific date, usually by the end of a month. NAV is the price at which the shares of the fund can be traded or redeemed. The NAV is commonly used for investors to view the holdings in their portfolio.
Discretionary investing means that buy and sell decisions are made at the portfolio manager's discretion, based on a pre-determined mandate. The term generally reflects investment decisions that are considered independently, based on in-depth fundamental analysis and are not triggered by systematic trading strategies.
Systematic trading means that buy and sell decisions, as well as risk management, are made according to pre-defined quantitative rules in a methodical way. Systematic trading can be either computer-automated or manual, although the former is the most common.
Systematic trading is related to quantitative trading.
Long-short investing means that the fund manager takes both long and short positions in investments typically from a specific market segment. Long-short investing seeks to take long positions in underpriced assets while selling short overpriced assets, aiming to identify relative value opportunities. Long-short investing is market-neutral, which means that the value of the fund is not affected by up and down movements of the overall market.
Directional investing means that the fund manager takes specific views of the future direction of the market or underlying asset. Directional investing is the opposite of long-short investing and it can be either long (if the fund manager believes an asset’s price will go up in the future) or short (if the fund manager believes an asset’s price will go down in the future).
Terminology for Statistics
Return is the yield that an investment generates over a period of time. It is the percentage increase or decrease in the value of the investment in that period. The most popular way of expressing returns is the Annualized Return.
If an investment has a value of $100 at the beginning of the period and a value of $110 at the end of the period, then the return for this period is +10%.
Annualized return is the amount of money an investment has earned per annum. It represents the annual return of an investment for a period of time, assuming that gains were re-invested every year. It is the best indicator of an investment’s performance but doesn’t give any indication about the ups and downs of the investment value during that period.
If an investment has a value of $100 today and a value of $121 in 2 years, then the annualized return for this investment is +10%.
Volatility represents how much an asset's price swings around its mean price. In other words, volatility shows how large up or down movements an investor should expect from an asset. Volatility is the most common measure of risk for an investment. In general, the higher the volatility, the riskier the asset.
In mathematic terms, volatility is measure as the standard deviation of an asset’s returns. Within Daedalus, volatility is measured as the standard deviation of a fund’s monthly returns, expressed in annualized terms.
If Investment 1 has volatility of 5%, while Investment 2 has volatility of 10%, then Investment 2 is expected to have sharper up and down movements, compared to Investment 1. Indicatively, the S&P500 has a historical Volatility of about 15%.
A maximum drawdown is the maximum observed loss from a peak to a trough of the value of an investment. It is a very representative indicator of downside risk and represents the amount investors should expect to lose at any particular period of their investment, before its value rebounds. A maximum drawdown helps investors know what to expect in a potential downturn.
The maximum drawdown of the S&P 500, during the financial crisis of 2007-2008 was about 50% from a peak in November 2007, to a trough in March 2009, before rebounding again.
The Sharpe Ratio is a measure that expresses the return of an investment, compared to its risk and is a snapshot of the quality of the investment. The Sharpe Ratio is the most widely used method for calculating the risk-adjusted return of an investment. In general, the higher the Sharpe Ratio, the better the investment.
If Investment 1 has an Annualized Return of 8% and Volatility of 16% and Investment 2 has an Annualized Return of 6% and Volatility of 9%, then Investment 1 has a Sharpe Ratio of 0.5 and Investment 2 has a Sharpe Ratio of 0.67. Investment 2 is better than investment 1, as it has a higher annualized return, compared to its volatility. Indicatively, the S&P500 has a historical Sharpe Ratio of about 0.40.
The Sortino Ratio is a variation of the Sharpe Ratio that distinguishes between upside and downside moves. Sharpe Ratio is calculated using both up and down movements of the value of an asset, which is not always what investors will be looking for as a risk measure. Sortino Ratio is also a measure of an asset’s risk-adjusted returns and expresses the return of an investment, compared to its risk, but takes only the downside risk and movements into account, ignoring upside movements.
Alpha in investing is a measure of a fund’s ability to beat the market over some period. Alpha shows how much profit the fund can generate over the market’s returns and expresses whether a fund manager can systematically earn returns that exceed the broad market as a whole (positive alpha) or not (negative alpha). The larger the alpha, the better the investment.
In mathematic terms, Alpha is equal to the constant of the regression of the fund’s returns, against one or more benchmark markets.
Beta is a measure of an investment’s exposure to systematic or market risk. Beta is an indication of how correlated an investment is with a benchmark’s ups and downs. In other words, it expresses how likely is the investment’s price to move when the market moves in a specific direction. Beta can be calculated for different markets and benchmarks, eg. S&P 500, US Government bonds, etc.
If Asset 1 has a large and positive beta with the market, then if the market goes up, Asset 1 will likely go up as well. If the market goes down, then Asset 1 is likely to go down as well. If beta is negative then Asset 1 will tend to move in the opposite direction to the market, while if the beta is close to 0 movements in the market do not affect the value of Asset 1.
Terminology for Fees
A management fee is charged by the Fund Manager for managing a fund. The management fee is quoted on an annual rate, as a % of the total AUM of the fund. The management fee is intended to cover the manager’s compensation, but also other administrative costs and is charged regardless of the performance of the fund. It is deducted directly from the fund and not charged separately to the investors. Within Daedalus, Fund Managers report the fund’s performance net of fees (after the deduction of any fees).
If a fund manager charges a management fee of 2% and the fund has an AUM of $100M, then the management fee is $2M for this year.
A performance fee is charged by the Fund Manager for generating positive returns. The performance fee is charged only if the fund has positive returns for the year and in some cases above a minimum threshold (hurdle rate). The performance fee is quoted as a % of investment profits. It is typically a feature of the hedge fund industry and aims to align fund manager’s and investors’ interests. As with the management fee, the performance fee is deducted directly from the fund and not charged separately to the investors. Within Daedalus, Fund Managers report the fund’s performance net of fees (after the deduction of any fees).
If a fund manager charges a performance fee of 20% and the fund has investment profits of $10M for the year, then the performance fee is $2M for this year.
An entry fee is charged at the point an investment is made. The entry fee is a one-off payment and is usually quoted as a % of the investment value. The amount that is finally invested in a fund is the total amount paid, net of the entry fee. Unlike the management and performance fee, the entry fee is usually charged directly to the investor at the point of the transaction. Entry fees range according to the sophistication and accessibility of the underlying funds.
If a particular investment has an entry fee of 2%, then an investment of £1,000 would require £20 to be paid as a one-off entry fee.
A hurdle rate is the minimum rate of return for an investment fund required by an investor. Within the Hegde Fund industry, the hurdle rate is used to specify the minimum return threshold that a fund manager needs to achieve, before triggering performance fees. The performance fee is charged on the investment profits over the hurdle rate.
Let’s assume that a fund has an AUM of $100M at the beginning of the year and achieves a 10% return for the year. The investment profits are $10M. If the fund manager charges a performance fee of 20% with a hurdle rate of 5%, then, $5M is deducted from the chargeable investment profits. The fund manager charges 20% of the remaining $5M of investment profits or a performance fee of $1M.