Asset Allocation
Funds: Asset Allocation
Funds attempt to manage your returns by using different asset
allocation strategies, depending on current economic conditions.
Their investment policies allow wide variances in the
percentages of stocks, bonds and cash that they can hold as they
try to advantageously "time" the market.
Average Coupon:
The dollar-weighted average interest rate, expressed as a
percentage of face value, paid on the securities held by a bond
portfolio.
Balanced Funds:
These funds are combinations of stocks, bonds and money market
securities. The characteristics of the fund depend on the
allocation of the fund's securities among the various
investments. These allocations are typically held fairly
constant over time.
Beta:
Measures a fund's sensitivity to market movements. Specifically,
beta measures how much a fund's excess returns (returns over
Treasury bills) have been tied to the market's excess returns.
By definition, the beta of the market is 1.00. A fund with a
beta of .85, for example, would have provided excess returns of
about 85% of the market's excess return. In a down year, this
fund has typically not fallen as much and, in good years, it has
typically not advanced as strongly as the market. However, beta
is a measure of historical volatility and cannot predict a
fund's future performance.
Blended Investment Style:
An investment strategy with attributes of both the growth style
and the value style of investing.
Bond:
A debt security (IOU) issued by a corporation, government, or
government agency. In most instances, the issuer agrees to pay
back the loan at a specific date and make regular interest
payments until that date.
Bond Funds:
Bond funds come in a variety of types from short-maturity,
high-quality types to long-maturity, "junk bond"
types. These are not insured funds, nor do they have stable
principal values even if they invest solely in U.S. Treasury or
government-guaranteed bonds. They may be subject to many sources
of investment risk. When interest rates rise, the value of the
bonds decreases (more with longer maturities), and vice versa.
If a company has credit problems or its rating is downgraded,
the value of its bonds can be affected. While bonds are
fixed-income investments, they are riskier than CDs, treasury
bills and money market funds, in some cases much more so. As a
result, investors expect higher returns over time which can
offset some of the inflation risk inherent in using "fixed
income" investments like bond funds for longer term
objectives.
Cash (CDs, Savings Accounts,
Treasury Bills): These
investments provide safety of principal and scheduled returns
(if held to maturity) and are ideal for short-term objectives
and liquidity needs. Because of their relatively low after-tax
returns, they are susceptible to inflation risk for longer term
investment needs.
Closed-end Funds:
Unlike open-end mutual funds, which are always issuing and
redeeming shares at net asset value (sometimes with a
commission), closed-end funds trade like an individual security
in a secondary market. Because of this, the securities can trade
at a discount (or premium) to their actual net asset value.
Commodity Funds:
These funds invest in commodities and commodity futures and
options. They are extremely volatile and should be considered
speculative investments, although some investors use these funds
for inflation hedges.
Company and Industry Risk:
Market valuations of companies that have publicly traded
securities are based upon expectations of the company's and its
industry's future performance. As these expectations change over
time, market values will adjust accordingly.
Credit Risk:
This risk usually relates to bond investments and refers to the
financial soundness of the firm which issued the bonds. The
higher the credit rating, the lower the expected return from
interest payments because of the very high likelihood of
receiving interest and principal back. (This helps most of us
sleep well at night!) The lower the credit rating, the higher
the bond return needs to be to attract investors, and the more
uncertainty involved in collecting both interest and principal.
For firms with high credit risk, and especially for bond issues
in default, the principal value of the bonds can fluctuate
greatly based on perceived changes in the firm's ability to
repay the bondholders.
Currency Risk: Investments
traded in foreign markets or which pay interest or dividends in
foreign currencies entail the risk of declines in the currency's
value relative to the U.S. dollar. Some investment managers
attempt to manage this risk with various hedging techniques.
These are not consistently effective, but diversification into
many major currencies can help limit this risk.
Duration:
This is a measure of the dollar-weighted average time until
receipt of all cash payments from a fixed-income security
expressed in years. "Macauley duration" is simply the
average time to receipt of all the scheduled interest and
principal payments on a bond. "Modified duration"
adjusts the Macauley duration to accurately measure how much a
bond's price can be expected to fall if interest rates rise by a
certain percentage, or vice versa.
Earnings Growth Rate:
This is a measure of the earnings growth record of a stock or of
the average stock in a portfolio. This average number is usually
weighted so that larger positions in the portfolio count
proportionately more than lesser positions
("dollar-weighted"). Stocks with losses and those that
lack a five-year track record are usually excluded from this
calculation.
Equity Stock Funds:
Equity funds carry substantial opportunity for higher returns
along with substantial risks of widely varying returns. There
are no guarantees of future values or earnings. The scope of the
funds includes Conservative (high-quality, blue-chip stocks
paying dividends), Index (match market returns), Aggressive
(growth companies not paying dividends and/or turn-around
companies), Sector (focusing on specific industries, which
reduces diversification), International (good quality foreign
companies, but subject to currency risk in addition to the other
sources of risk), International Sectors (focusing on specific
countries or blocks of countries, for example, European Equity
Fund), and Emerging Market (stocks of companies in developing
non-established countries, such as the Pacific-Rim Emerging
Growth Fund, subject to substantial risks including currency and
liquidity of the markets). Equity funds historically have been
the best long-term inflation hedge available among mutual funds,
but they typically suffer along with other financial assets at
times when inflation rates are increasing rapidly.
Global Funds: These
funds combine both U.S. and foreign securities. A Global Bond
Fund includes both U.S. and foreign company and government
bonds. A Global Government Bond Fund has only U.S. and foreign
government securities. Global Equity Funds contain both U.S. and
foreign equity securities and are subject to many sources of
investment risk and currency risk. Both international and global
funds have a unique characteristic which can enhance long-term
portfolio returns: most international equity and bond markets
are not fully correlated with the U.S. markets, and in some
cases, very little correlation is exhibited. Because of this,
modest percentages of international exposure can actually reduce
the total risk of your entire portfolio, and can at times
provide increased returns. When investing in international and
global funds, it is important to understand how much of the
historical returns have been due to the securities' performance
versus how much was due to currency changes.
Growth Investment Style:
Investment orientation that focuses on stocks of companies with
proven records of earnings growth, and is typically willing to
"pay up" for stocks of companies with the best records
and prospects.
Hedge Funds (Leveraged Funds):
Hedge funds are speculative funds which make large bets on
market movements. They utilize borrowed money to substantially
leverage their returns (and losses), often at a factor of ten to
one, or more. They purchase exotic securities and also take
substantial short positions when they think the market or a
particular sector of the market will go down. Such funds are
extremely risky and are suitable for high-wealth investors only.
Inflation Risk (Purchasing
Power Risk): When
putting your portfolio together and when making adjustments and
revisions, there is an overriding risk that you must consider in
order to maintain or increase your standard of living. Inflation
does not touch your principal value, but it does steal your
future purchasing power. A portfolio that is intended for longer
range needs, but is entirely invested in low risk/low reward
investments, can actually provide you with less purchasing power
(especially after taxes) at the end of the period than at the
beginning, even though you minimized all of the other sources of
risk along the way. Always review your results in terms of
after-inflation (and after-tax) returns, especially for your
long-term objectives (like retirement) which are at the most
risk from inflation.
Interest Rate Risk: Investors
in bonds and bond funds must be acutely aware of the risk
associated with interest rate changes. When interest rates rise,
the values of outstanding bonds fall, and vice versa. In a
rising rate environment, while you are receiving monthly bond
interest payments as scheduled, your total returns may be
eroding because of declining principal values. This is
especially true with longer term holdings. Longer term bond
issues (for example, 30-year Treasury Bonds) are much more
sensitive to interest rate changes than short- or
intermediate-term issues.
Lehman Aggregate Bond Index:
This is a composite index of the Lehman Brothers
Government/Corporate, Mortgage-Backed and Asset-Backed indexes.
It includes fixed-rate debt issues rated investment grade or
higher by Moody's, S&P, or Fitch. All issues have at least
one year to maturity and an outstanding par value of at least
$100 million for U.S. government issues and $50 million for all
others. All returns are market-value weighted inclusive of
accrued interest. The modified duration of this index is
currently about 4.6 years.
Market Risk:
The values of marketable securities fluctuate every day.
Sometimes these changes in value have nothing to do with the
real "value" of the investment but instead are
influenced by a variety of unrelated events such as political
changes, congressional actions, U.S. and foreign activities, or
a psychological swing in the market "mood".
Maturity (Bonds):
· Average
Maturity: The
dollar-weighted average length of time until bonds held by the
portfolio reach maturity and are repaid. In general, the longer
the average maturity, the more a portfolio's share price will
fluctuate in response to changes in market interest rates.
· Short:
Maturity of 4 years or less.
· Intermediate:
Maturity of 4 to 10 years.
· Long:
Maturity more than 10 years.
·
Money Market Funds: MMFs
pool investors' money to purchase short-term investments such as
jumbo CDs, commercial paper (short-term IOUs) of corporations,
and treasury bills. Because of their size, they allow investors
to get slightly better returns than if the investor purchased
CDs or savings accounts individually. These accounts are not
insured and reflect changes in interest rates daily. They have,
however, been extremely safe in preserving principal over their
history, but should not be expected to offset inflation risk for
long-term objectives.
Price/Earnings Ratio:
For a stock, this is the ratio of the current price relative to
the current year's earnings per share. For a fund it is the
dollar-weighted average of the price/earnings ratios of the
stocks in the fund's portfolio.
Quality (Bonds):
· Average
quality: An indicator
of credit risk, this is the dollar-weighted average of the
credit ratings assigned to a portfolio's holdings by
credit-rating agencies. Agencies assign credit ratings after
appraising an issuer's ability to meet its obligations.
· High
quality: Ratings of AAA
and AA.
· Medium
quality: Ratings less
than AA but greater than or equal to BBB.
· Low
quality: Ratings below
BBB.
·
Small Cap:
Companies with market capitalizations in the $250 million to
$1.5 billion range are considered "small cap".
Earnings for these companies often are expected to grow faster
than earnings of the overall market which, in turn, could
increase the stocks' share prices.
S&P 500:
This market value-weighted index of 500 widely held stocks is
often used as a proxy for the stock market. It is heavily
influenced by the largest issues, making it a "large
cap" index. The capitalization size is normally at least
$1.5 billion. Included are the stocks of 400 industrial
companies, 40 public utility companies, 40 financial companies,
and 20 transportation companies. This composition is flexible
and the number of issues in each sector has varied as relatively
unsuccessful companies have been frequently replaced with more
successful companies.
S&P 400:
This market value-weighted index consists of 400 widely held
stocks. These are primarily stocks in the middle capitalization
range ($1.5 billion to $7.5 billion market value). Any midcap
stocks already included in the S&P 500 are excluded from
this index, which was started on December 31, 1990.
Standard Deviation:
This statistical measure represents the degree of fluctuations
in historical returns. The higher the standard deviation, the
greater the volatility of returns. It is calculated using
historical period returns to determine a range of returns around
a mean. For example, a fund with an average annual return of 10%
and a standard deviation of 5 would have provided a return
between 5 and 15% about 68% of the time. Standard deviation, a
historical measure, should not be used to predict fund
performance.
Total Holdings:
This is simply the number of individual securities included in a
portfolio. It is an indicator of diversification. The more
separate issues and sectors a portfolio holds, the less
susceptible it is to a price decline stemming from the problems
of a particular issue or sector.
Total Return:
This return measure represents the percentage change, over a
specified time period, in a fund's value, with the ending value
adjusted to account for the reinvestment of all distributions of
dividends and capital gains as received.
Value Investment Style:
This investment style focuses on stocks that are believed to be
undervalued in price relative to the underlying companies'
intrinsic values and will eventually be recognized by the
market.
Weighted Average Market
Capitalization: This is
the average market value of all outstanding common stock of
companies included in a portfolio, weighted in proportion to
their percentage of net assets in the fund.
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