Resources
Introduction to Investing
Understanding some industry jargon
Asset Classes
A grouping of securities that demonstrate similar risk and return characteristics, behave similarly in the marketplace and are subject to similar laws and regulations. The four main asset classes are equities (shares), fixed income (bonds), cash and property. Different asset classes are expected to behave and perform independently in any given market environment.
Sub-Asset Classes
A further breakdown into sub-asset classes can occur in certain categories, for instance equities drops into Large Companies (Large growth cap), Value Companies and Small Companies (Small growth cap).
Asset Allocation
This describes how investment funds are spread across the main asset classes and sub-asset classes, with further breakdowns by geographical spread and duration to maturity (re bonds). For instance equities may be split into NZ, Australia, Emerging Markets and Global (excluding the three former categories).
Value Equities
When discussing equities there is talk of ’growth’ and ‘value’ stocks. The latter represent those companies with high underlying asset values relative to their current share price (‘High Book to Market’). Frequently ‘value’ companies are moving through a period of consolidation after a major structural change to the business or major change in management.
Growth Equities
Companies that have traditionally delivered strong bottom-line profits and been at the forefront of their sectors for many years, with good solid track records, are referred to as ‘growth’ stocks. Typically these have lower underlying asset value relative to share price and are therefore regarded as ‘Low Book to Market’.
Corporate Notes
Fixed interest securities that typically pay a fixed interest rate (coupon) over the life of the asset. Often issued for a defined period – perhaps 5 years and at maturity are repayable, rolled-over with new terms, occasionally converted to shares, at the behest of the issuer. In the past few years some of these notes have carried ‘resets’ that strike on defined dates whereby the interest rate is reset (usually to a rate above 90-day bill rates, or other identifiable base). Often un-rated.
Bonds
Confusion can arise between bonds and corporate notes. A true bond is issued for a defined period with a fixed coupon and repayable in cash at maturity. Government Stock is the most well-known bond. Bonds typically offer greater security and inevitably carry a S&P credit rating.
Preference Shares
Another fixed return security, typically, though can also be subject to ‘resets’. A preference share effectively pays a dividend that is more like an interest payment in that it is predictable and takes ‘preference’ over ordinary share dividends. Typically payments to investors carry a fully imputed tax credit at 30%. The very nature of preference shares is that they are perpetual (though occasionally they are issued with a defined maturity date).
Risk and Return
In investment terms you cannot have one without the other. Risk in our terminology equates to volatility, however risk in more speculative areas of investment can involve permanent capital loss. All investment carries an element of risk. In some cases that risk is infintisimal – for instance, Government Stock – the chance of a western government defaulting is a gnat’s breath above zero. With risk comes return and all investment has a close correlation between the two. Greater risk typically offers greater return, likewise money in the bank or Government Stock, offers a relatively poor return. The objective of a globally diversified investment portfolio is to significantly reduce risk through prudent diversification and to maximise returns for any given risk level. Investors need to be certain that they understand risk attached to any investment and be convinced that they are being adequately rewarded for any risks they take – known as the ‘risk premium’.
Inflation-proofing
In investment planning when we refer to ‘inflation-proofing’ we are signalling the intention to protect the ‘buying power’ of an investor’s capital. In much of our planning we set the expected inflation rate between 2 and 3% per annum. Planning for the inflationary effects is crucial particularly for those with long time horizons and/or in high inflation periods.
Research
Research into any form of investment is crucial if investors are to avoid catastrophic loss of capital. In designing investment portfolios we refer back to specialists in the asset classes we are contemplating and draw expertise and knowledge that allows us to minimise risk and maximise returns. Independent research houses are able to provide analysis and assessment of managed funds, both wholesale and retail.
Balanced Portfolio
Many investors consider themselves middle-of-the-road when it comes to risk and return, considering themselves as ‘balanced’. A portfolio demonstrating these characteristics will typically have around a 50/50 mix of ‘growth’ assets (equities and property) and ‘defensive’ assets (cash and bonds).
Equities
For equities read ‘shares’.
Risk Profiling
Each investor will have a risk profile (or defined mix of assets with which they are comfortable through strong and poor years). The profile is typically determined through a questionnaire whereby deep-searching questions are asked around possible volatility and capital loss, around risk adopted in everyday life, about an investor’s job (whether on pure salary or commission only); and these answers are compared to the adult population as a whole thereby setting a rating, or profile. These can range from being totally risk averse to being very aggressive and every point in-between. As one moves through life, especially towards and into retirement with a consequent loss of income, a risk profile typically moves towards the more safe and secure end of the spectrum.