Investment terms you need to know

20 August 2012

The investment world sometimes seems like another planet. You’d like to visit but you have no idea where to go or what to do. It doesn’t help that when you finally venture into it, everyone seems to be speaking a strange language.

You need to be armed with the right vocabulary to master this strange new world. In the third lesson of Moneywise's Investment School, we offer a translation service - laying bare the language of investment.

Investment vehicles

The first thing to understand is what an investment vehicle is. Put simply, it's what you put your money in and there are two main types - unit trusts and investment trusts.

A unit trust, or open-ended investment company (OEIC), is 'open-ended', which means it can continue to take cash from everyone who wants to invest for as long as there are willing investors. The value of the fund will rise and fall with the value of the assets it holds.

An investment trust is similar in many ways but is 'closed', which means instead of an infinite number of people being able to invest, the fund is split into shares of which there are a fixed number. You buy into the fund by buying these shares, and sell up by selling the shares on to another investor.

Because investment trust companies are quoted on the stock exchange, the price of shares is determined by the stockmarket according to supply and demand, and may not equal the underlying value of the trust's own investments, known as its net asset value or NAV. This means they can be sold at a discount or a premium from that value.

Another big difference is that investment trusts can borrow money in order to invest, a process known as gearing. This magnifies its exposure to market movements, boosting returns in the good times but increasing losses when markets fall.

Once you’ve picked the unit or investment trust you want to invest in, the next thing you need to decipher is the key features document from the fund management company. This is your roadmap to the fund.

You'll come across the investment objectives in it first, which explain the kind of things it invests in, the limitations and the strategy of the fund.

Within the investment performance section you'll find a host of information, including a chart showing past performance for a number of years (cumulative performance) and a table of growth each year for the past five years (discreet performance). The authorities have drummed it into us that past performance is no guide to the future but it does hold clues.

Take the Fidelity Special Situations fund, for example. A glance at performance tables shows that if you invested £1,000 a year ago it would be worth less than £950 today. If you invested the same amount three years ago it would be worth just under £1,400, and if you invested it 10 years ago it would be worth just under £2,500.

From this we can see it's a volatile fund that invests in companies with the potential to do better than their rivals, or much worse. It tells you about the risks you are taking.

There are a few other things to look at. One is the quartile a fund has been in. This tells you how it does in comparison with funds that are fairly similar. If it is first-quartile consistently then it generally outperforms, and if it is fourth, then it underperforms.

Take the well-liked Artemis Income fund. Over the past year it has been first-quartile, over three and five years it was second, and since launch it has been first-quartile. This isn’t a guarantee that this performance will continue but shows robustness in the past. Of course, the quartile positioning needs to be taken with a pinch of salt.

Not every fund in the sector is aiming to do exactly the same thing so we wouldn’t expect the performance to be the same.

Star ratings

Another thing to familiarise yourself with is the star rating. A number of companies offer these, including Morningstar, FE Crown Ratings and Lipper.

These do in-depth investigations into the funds, their strategy, management, past performance, volatility and everything else. Then they give them an overall star rating.

Morningstar gives between three and five stars depending on how well they’ve performed compared with similar funds (adjusted for things such as risk and charges).

Likewise there are FE Crown Ratings, which award up to five crowns on a similar basis. Lipper is more complex because ratings are given in categories including: total return, consistent return, preservation, tax efficiency and expense.

The top funds are called Lipper Leaders, the rest are ranked 1 to 4, where 4 is best. Of course, it doesn’t help that the ratings agencies don’t always agree on what makes a good fund but a generally strong showing across them is a good sign. Artemis Income, for example, has five stars from Morningstar and three crowns from FE.


The key features document also contains information about charges - starting with the initial charge, or entry charge . If you invest through a fund supermarket you'll get a good discount on this and bring charges that can be up to 5% down closer to 1.25%.

It will also list the ongoing charges or annual charges, including the annual management charge, or AMC, which covers the cost of the research and expertise of the fund managers, the administration charge, the registrar charges and the fund expenses, which cover things such as the fees it needs to pay.

These are often added together to show you a total expense ratio, or TER, which covers most of the charges your fund faces in a year.

Also look out for performance fees. These are more common in some sectors than others so, for example, absolute return funds are more likely to have them. Take the Cazenove Absolute Target fund. It will charge 20% a year of the increase in the NAV of the fund in every year it makes a profit.

Once you have mastered the basics, there are specialist investment sites with their own measures, from the sharpe ratio to the alpha and beta returns.

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