The investment world loves a flutter of jargon. It makes commentators sound ever so clever. Yet behind this flamboyant lexicon are often some fairly simple, easy-to-grasp concepts. Here is a collection of articles seeking to extract the crux from the complex, the idea from the over-engineered.
Alpha and Beta
Alpha and beta are two concepts deemed so highbrow that they are deserving of a Greek letter apiece.
Economic theory had for centuries blindly assumed that the common man was a rational being in perpetual possession of perfect information. Behavioural Finance is the strike-me-down-Judy body of knowledge that admits people are not and do not.
Bull and Bear Markets
There can be few words of investment jargon used so casually as bull and bear. The terms have the brand power of a hoover or a biro. The great Wall Street broker, Merrill Lynch, was nicknamed ‘The Raging Bull’ (until it inappropriately went bust in 2008).
Contango and Backwardation
It may sound like a line from Bohemian Rhapsody, but the concept of contango is far removed from two left feet haphazardly hurtling around a dusky Latin American ballroom. Instead we are venturing into the jargonerific world of the futures market.
Contingent Convertible Bonds
Do you remember the mid-1990’s film Speed? It was not a complex plot: a bus would blow up if its speed dropped below 50mph and Sandra Bullock had to keep driving it very fast or else all the passengers would die. Good. You are already half way to understanding Contingent Convertible Bonds, or CoCo’s.
Correlation ought to be a straightforward topic. It simply describes how closely two prices move in tandem. This is important in the investment world as we need to know whether the assets in all our portfolios tend to go up and down at the same time or not.
Costs and Charges
Think of the true cost of investing as a North Atlantic iceberg. There is the visible mound afloat (commissions, administrative fees, annual management charges and taxes), but a far more substantial body of potentially Titanic-sinking frozen water hidden from view below the surface (the bid-ask spread, market impact, delay costs and missed opportunity costs).
Cyclically Adjusted Price-to-Earnings Ratio
The cyclically adjusted price to earnings (CAPE) ratio has risen to considerable prominence in recent years. It is typically allied with the argument that equities in general, and the American market in particular, are expensive. It is a weapon of choice for bears.
A discourse on diversification inevitably involves talk of eggs and baskets, yet I confess my breakables are rarely so carefully divided. As one of my colleagues frequently tells me, if you’re not living on the edge you’re taking up too much room. I go further: my entire grocery shop is fearlessly thrown into the one and same basket. Indeed, there is a rash absence of diversification permeating through my entire existence.
I will make what I think is a fair assumption that many of the features of bonds are familiar territory. Yield, coupon, maturity and maybe even price. All these are intuitive and mostly jargon-free. But what about ‘duration’? The word is readily bandied about and almost always adjectivally appended. A browse through the IMA bond sectors tells us that duration may be short, reduced, low, low average, long, ultra-long and even hedged.
The financial world loves an acronym. Actually it is obsessed by abbreviation and jargon to the extent that it has almost created a new language. It is an uncommon talent for two protagonists to engage in a conversation that would be incomprehensible to anyone not in the know. In our world it is all too easy. This article tackles ‘EV’ or, to give it its full title, Enterprise Value.
There is much in common between financial markets and physics. The apparent similarities can be as simple as arguing that share prices, like electricity, follow the path of least resistance. Or they can stretch the minds of the finest quantum mechanics. Gearing, however, takes us into the world of motor mechanics.
You could be forgiven for believing that the popular nursery rhyme Mary, Mary, Quite Contrary is an 18th Century lamentation on the downfall of English Catholicism, culminating specifically in the beheading of Mary Queen of Scots. But that, in our view, is an erroneous interpretation.
High Frequency Trading
It could be the title of a Sherlock Holmes novel. The Hound of Hounslow describes how one man and his algorithm in West London allegedly managed to temporarily wipe $1 trillion of value from US stock markets in minutes. Welcome to the age of high frequency trading.
Price-to-Earnings vs. Price-to-Book
Knowing how much to pay for an asset is a vital skill for the successful investor. Herein we introduce two metrics that approach the concept of valuation from two quite different perspectives: the price-to-earnings ratio (P/E) considers a company’s value to be in its ability to generate profit, while the price-to-book ratio (P/B) prizes a company’s chattels in excess of its charges.
Put and Call Options
We’re in pre-Socratic Greece, somewhen around 600 BC. A certain Thales of Miletus, convinced that the forthcoming olive harvest will be bountiful, purchases a contract (for 5 drachma) that bestows on him the right – but not the obligation – to reserve an olive press in Miletus for 100 drachmae.
Quantitative easing is habitually snappily foreshortened to ‘QE’. Unusually for a financial acronym, QE is grammatically helpful. It is an easing of monetary conditions by the creation of a specific quantity of money.
We think of investment risk as similar to the multi-headed, serpent-like Hydra encountered by Hercules. Risk is multi-headed. It is also susceptible to mythical hyperbole. The modern investor is obsessed by risk to the point of madness. The trouble is that it is so badly misunderstood.
There is certain undeserved mysticism to the share buyback. There are few greater alleged accolades than for an overview of a business to conclude with “…and they’re buying back their shares”. Therein lies an implication of double praise.
The Sharpe Ratio is one of the most commonly used measures of investment performance. It was neatly designed to combine performance with risk and thus to address one of the core clichés of investment – you have to speculate to accumulate.
Short Selling and Stock Lending
Equity investment used to be such a simple idea. You bought shares, the price went up and then you sold them for a profit. If the price went down you held on, received the dividends and told everyone that you were a long-term investor.
We live in an ironic world. Common sense is definitely not all that common, social networks are decidedly anti-social, and I can’t think of anything less “smart” than my so-called Smart TV. Below we size up “smart beta”.
Structured products did not have a great start in the UK retail market, and they still struggle to shrug off some unbecoming misconceptions. The legacy of “precipice bonds” still sends shivers down the spine. In the right hands, however, structured products can be an invaluable part of your portfolios.
Value at Risk
In a league table of the most misunderstood investment tools of all time, Value at Risk (VaR to its friends), is probably the bookies’ favourite for a medal. VaR emerged in the 1990s as the then latest über-clever risk management tool that boldly sought to quantify, in terms of pounds and pennies, the amount a portfolio or trader has on the proverbial casino table.