Investments - Glossary

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Investments - Glossary

This Glossary identifies, defines, and clarifies the meaning of investment terms used by MainePERS in investment policies. See also Glossary of Commonly Used Private Investment Fund Terms.^[1]

Active Management		An approach to money management where the manager seeks to beat a predefined benchmark. Typically, higher fees are associated with this type of management, as you are paying a money manager for their ability to “add value” relative to passively investing in the benchmark. These managers typically take on greater “benchmark risk” (i.e. a greater likelihood of deviating from the benchmark).

Actuarial Accrued Liability		The present value of the estimated cost of benefits payable to active and retired members covering service rendered prior to the date of an actuarial valuation as determined by use of assumptions about the future and an actuarial cost method.

Actuarial Assumptions		Assumptions which are made for the purposes of determining the contribution which must be made in order to fund the future liabilities. Actuarial assumptions are generally grouped into two categories: demographic (i.e. life expectancy, rate of retirement, number of years worked, etc.) and economic (inflation rate, the return on investments, etc.).

Asset Allocation		This is the process of diversifying investments among a variety of asset classes. Through this process, risk to the portfolio is reduced, as it is expected that the various asset classes will act differently under a variety of economic scenarios.

Asset Class		A group of investments that share similar characteristics. Types of asset classes include stocks, bonds and various alternative investments such as commodities, timber, real estate and cash.

Basis Point		A unit of measurement equal to 1/100th of one percent. For example, 0.53% is equal to 53 basis points. 1.00% is equal to 100 basis points.

Benchmark		A tool utilized to measure the performance of a manager relative to the universe of securities in which they invest. Typically, benchmarks consist of a broad array of investments within a particular market.

Beta		This is a measure used to determine a portfolio’s sensitivity to movements in a particular market or asset class. In technical terms, it is the expected percentage change in return for a portfolio based upon a 1% change in the market or asset class. For example, if the S&P 500 is up 1% for the month and a portfolio has a beta of 1.2, you would expect the portfolio to be up 1.2% (or 20% more than the market). Essentially, beta helps to measure a portfolios risk (volatility) relative to the market or asset class it is compared to.

Correlation		The simultaneous change in value of two numerically valued random variables.

Correlation Coefficient		A measure that determines the degree to which two investments’ movements are related. If two investments have perfect positive correlation (+1), you would expect them to move in lock-step with one another. If two investments have perfect negative correlation (-1) you would expect them to move in the mirror image of one another. Between perfect positive and perfect negative (+1 or -1) you have a scaled relationship between the two investments. A correlation of zero (0) implies no relationship between the movements of the two investments.

Current Yield		The annual rate of return on an investment, expressed as a percentage. For bonds and notes, it is the coupon rate divided by the market price. For stocks, it is the annual dividends divided by the purchase price.

Derivative		A financial instrument whose value and characteristic is derived from the performance of some underlying investment, such as a stock, bond, commodity, or currency. Derivatives are often used to help large investors manage their risks and gain exposure to various investments at a relatively low cost compared to holding the underlying asset. Examples of derivatives include futures and options contracts.

Domestic Equity		This sub-asset class consists of stocks in U.S. companies. A stock essentially represents ownership in a company. This sub-asset class seeks to provide long-term capital appreciation and dividend income that together exceed inflation. Domestic Equity may include large, medium, and small capitalization stocks and stocks of differing investment styles (i.e. growth, value, active, passive, etc.). Descriptions of each style are as follows: Large Capitalization Growth Stocks: These are stocks whose market capitalization is in excess of $5 billion according to the Morningstar database. In addition, these stocks possess the characteristics of growth companies, which in technical terms means that their price-to-earnings ratio is greater than the market average. It is expected that these stocks have the potential to increase earnings per share at a faster rate than the average stock within the market. Large Capitalization Value Stocks: These are stocks whose market capitalization is in excess of $5 billion according to the Morningstar database. In addition, these stocks possess the characteristics of value companies, which in technical terms means that their price-to-earnings ratio is below the market average. These stocks are typically associated with mature companies that are expected to payout a larger portion of their income in the form of dividends than their growth counterparts as opportunities to reinvest this income back into the company at above average growth rates are limited. Small Capitalization Growth Stocks: These are stocks whose market capitalization is below $1 billion according to the Morningstar database. In addition, these stocks possess the characteristics of growth stocks, which in technical terms means that their price-to-earnings ratio is greater than the market average. It is expected that these stocks have the potential to increase earnings per share at a faster rate than the average stock within the market. Small Capitalization Value Stocks: These are stocks whose market capitalization is below $1 billion according to the Morningstar database. In addition, these stocks possess the characteristics of value companies, which in technical terms means that their price-to-earnings ratio is below the market average. These stocks are typically associated with mature companies that are expected to payout a larger portion of their income in the form of dividends than their growth counterparts as opportunities to reinvest this income back into the company at above average growth rates are limited.

Due Diligence		The process of investigating the details of potential and ongoing investments and managers by investors. The details include examination of the operations, management and verification of the material facts surrounding the investment.

Duration		This is a measure that reflects the change in the value of a fixed income security that will result from a 1% change in interest rates. Duration is stated in years. For example, 3 year duration means the bond will decrease in value by 3% if interest rates rise 1% and increase in value by 3% if interest rates fall 1%. Duration is used as a measure of the volatility of a bond. Generally, the higher the duration (the longer an investor needs to wait for the bulk of the payments), the more its price will drop as interest rates go up. Of course, with the added risk come greater expected returns. If an investor expects interest rates to fall during the course of the time the bond is held, a bond with a long duration would be appealing because the bond's price would increase more than comparable bonds with shorter durations.

Efficient Frontier		This is the line on the risk/return graph which reflects all of the “efficient portfolios” one can invest in, given the investment choices available. An efficient portfolio is a portfolio that provides the greatest expected return for a given level of risk, or the lowest risk for a given expected return.

Emerging Markets Equity		Emerging Markets Equity is a sub-asset class consisting of equity investments in companies in countries where the per capita income is below a predetermined level. Examples of emerging market countries include India, Brazil, South Africa, Mexico, Russia, Malaysia, Turkey, Poland, South Korea, Chile, and China to name a few. Emerging Markets Equity seeks to provide an opportunity for long-term capital appreciation in excess of inflation. This sub-asset class invests in countries where higher growth rates are expected, and thus one would expect higher returns. The emerging markets allocation provides another level of diversification for the total portfolio. Experience has shown that the emerging markets can be very volatile, however, as a part of the total portfolio, it can serve as an additional diversifier, reducing risk for the entire portfolio.

Futures Contract		A standardized, transferable contract that trades on an organized exchange that requires delivery of a specified investment (stock index, stock, bond, currency) at a specified price at a predetermined date. Essentially, this allows one to replicate the performance of an investment without holding the underlying investment. (i.e. you can obtain the return of the S&P 500 by owning an S&P 500 futures contract and you don’t have to own all 500 stocks in the S&P 500 index.)

Funded Ratio		This number reflects the percentage of total liabilities that the System has already funded based upon the actuarial value of the assets. For example, if the System has a funded ratio of 96%, it implies that the System could pay 96 cents of every $1 owed to beneficiaries at that point in time.

Information Ratio		This is a measure used to determine how effectively a manager is able to add excess return above a benchmark (alpha) relative to the risk (tracking error) they have taken above the risk of their benchmark. The higher the information ratio the better the risk adjusted return of the manager has been.

Policy Portfolio		This is a combination of the Dow Jones U.S. Total Stock Market Index, the Morgan Stanley Capital International All Country World ex-U.S. Index (ACWXUS) Index, the National Council of Real Estate Investment Fiduciaries (NCREIF) Index, the Dow Jones Wilshire Real Estate Securities (RESI) Index, the Custom Fixed Income Index, LIBOR plus an annual 3%, the Consumer Price Index (CPI) plus an annual 5%, and the Dow Jones U.S. Total Stock Market Index plus an annual 3%.

Yield Curve		The relationship between time to maturity and the yield for fixed income in a given risk class.

Yield to Maturity		This is the current yield on a bond plus or minus the price appreciation/depreciation during the life of the investment. Essentially, it is the yield that would be realized on a fixed income security if it were held until the maturity date.

Yield Spreads		The differences in yields on different types of fixed income securities which are a function of supply and demand, credit rating, and anticipated interest rate changes. Generally, the greater the “spread” of a bond compared to a US treasury bond, the greater the risk of that particular bond investment.

Glossary of Commonly Used Private Investment Fund Terms ^[1]

Advisory Committee		A group of third party advisors to the fund who are usually representatives of the limited partners.

Alternative Investments		An investment that is not an investment in one of the traditional assets types—stocks, bonds, or cash. For MainePERS, the Alternatives Asset Class includes real estate, private equity, infrastructure, and opportunistic funds.

Buyouts & Distressed Debt (Private Equity)		Investment in the equity or debt securities of a mature company. The company may be a private company, a division of a larger organization, or a public company that is becoming a private entity.

Capital Commitment		Amount of capital an investor is obligated to invest in a fund.

Capital Call or Drawdown		A request by the general partner obligating an investor to fund all or a portion of its capital commitment for the purpose of paying management fees and expenses and/or acquiring an investment.

Carried Interest		The general partner’s share of the fund’s profits. Buyout managers typically take 20% of profits. Venture managers may take 20% to 30% of profits. Carried Interest is typically paid after the investors have received distributions equal to the capital they have invested in the fund to date (or in a particular deal in certain circumstances), including fees and expenses, and after the investors have received their preferred return, if any.

Distressed Debt		Investment in debt securities of a company that is in financial or operating distress.

Distribution		Cash or equity returns distributed to fund investors.

Early Stage		A private company that is developing a product and involved in initial marketing, manufacturing, and sales. The company may be generating revenue.

Expansion or Late Stage		A private company that is selling its products. The company is generating revenue and may be profitable.

General Partner (GP)		The partner responsible for the management and investment decisions of the fund.

GP Clawback		To the extent that the general partner receives more than its agreed upon share of the profits due to losses later in the life of the fund, the general partner will be required to pay back the excess amount to the limited partners.

Infrastructure		An investment in the basic physical systems of a country or business and includes transportation, communication, water, sewer, waste, and energy systems.

Invested Capital		Amount of capital contributed by fund investors and invested in Portfolio Companies.

Investment Period		The period of time within which the fund may make investments. The investment period is typically five or six years for venture or buyout funds. The investment period may be shorter for debt-related funds.

Key Person		Key members of the management team of a fund. Key person provisions attempt to ensure that key persons are sufficiently involved in the activities of the fund.

Leveraged Buyout		Acquisition of a company by purchasing a majority of equity. One or more private equity firms invest in a company's equity and lenders provide debt financing that is typically secured by the assets of the company.

Limited Partnership		A legal entity with one or more general partners and one or more limited partners formed in accordance with the applicable statutory provisions of the jurisdiction of formation. A limited partner is liable only to the extent of the amount of money that partner has invested or committed to invest, while a general partner is fully liable for the debts and obligations of the partnership.

Limited Partner (LP)		A partner that has no responsibility for the management of the partnership and with liability generally limited to the amount of its capital commitment. An LP is a passive investor in the fund.

Management Buyout		Acquisition of a majority of or all of a company’s equity securities by existing management, typically with private equity financing.

Management Fee		Compensation for the management of the fund paid by the limited partners to the general partner (or a management company appointed by and typically affiliated to the general partner). Management fees range from 1% to 2.5% of aggregate committed capital while the fund is actively investing its capital. Fees are typically reduced once the investment period has ended, or when the manager forms a successor fund.

Minority Investment		The purchase of less than 50% of a company's equity securities. The private investment fund manager may negotiate negative control provisions to control its exit from the investment or the company's capital expenditures.

Net IRR		Annualized internal rate of return net of fees and the manager's profits. Net IRR is used together with the TVPI multiple to assess the performance of a fund.

Opportunistic		An investment strategy that generally has traditional market exposure, but seeks to take advantage of a unique or transient opportunity that has arisen due to an unanticipated market disruption.

Preferred Return		The minimum return to limited partners before the general partner is entitled to its carried interest. Buyout and debt funds typically have a preferred return of 7% to 8%. Venture funds typically do not have a preferred return. The preferred return is typically vanishing (i.e., after the preferred return is paid, the GP will receive distributions of carried interest on all profits, as opposed to profits net of the preferred return).

Private Investment Fund		An investment vehicle exempt from certain securities laws and regulations and typically structured as a limited partnership. Limited partner interests are sold through private offerings to sophisticated, institutional and high-net-worth investors. Private investment funds include, among others, private equity funds (or buyout funds), venture capital funds, hedge funds, distressed debt funds, real estate funds and infrastructure funds

Portfolio Company
or Portfolio Investment		A company or investment held by a private investment fund.

Real Estate		An investment in buildings or land located throughout the US and the world.

Secondary Acquisition		The purchase of a security from a person other than the issuer or underwriter of such security. In the private investment fund context, secondary acquisitions involve the purchase of (i) limited partner interests from investors, or (ii) portfolio companies of private equity or venture capital funds (secondary direct acquisitions).

Seed Stage		A private company involved in the research and development of an initial business idea.

Term		The duration of the fund. Typically, the term is ten years plus up to three years of possible extensions.

Total Value		The value of total distributions to investors plus the fair value of the existing portfolio.

TVPI		Total value to paid-in capital ratio. A fund's total value divided by invested capital.

Unfunded Commitment		An investor's remaining (uncalled) capital commitment to the fund.

Venture Capital		Investment in the equity securities of a private company.

Vintage Year		The year that the fund started investing in portfolio companies.

^[1] Adapted from materials prepared by Cliffwater, LLC