In this section, I explain some of the terms used on this website. I explain them in context of their usage herein. This may differ from their traditional usage, or technical definition. For this I make no apologies.
Usually defined as the risk adjusted outperformance or added value of a particular strategy. It is supposedly the x-plus that a skilled trader or investor will achieve, due to their particular edge. For a technical definition, see Alpha (investment) – Wikipedia.
Portable Alpha has been used to describe strategies that are independent of any beta factor (such as market, region or sector). It is meant to refer to the pure value add of a particular manager or strategy, irrespective of all external factors. In retrospect, many so called portable alpha strategies exhibited a degree of correlation with markets (and hence a beta), so are not as portable as what was once mooted.
This is what its all about…
In traditional investments, beta is regarded as the volatility or systematic risk of the investment, when compared to the market as a whole. See Beta Definition | Investopedia for a description in this context. In this definition, no reference is made as to what the “market as a whole” actually is. I tend to think of beta loosely as the desired market factor to which one wants exposure.
This factor may be a traditional market (usually defined by a capitalisation weighted index), or it may be a market, or industry sector. Beta can encompass a country or geographic region. It may be the whole world, which can be segmented economically (into emerging and developed markets for instance), or by company size (small, mid and large cap.).
Furthermore, the concept of beta can equally apply to other asset classes (such as commodities or fixed income) or a stratification by any other characteristic (such as, liquidity or even growth, momentum, volatility or yield). In this context, beta is more akin to a desired exposure dimension, rather than the systemic exposure relative to a market.
On usage: I take beta as the factor to which exposure is desired. For example, my beta may be developing markets, the Pacific rim, growth, or another factor. I would use an index or other benchmark to quantify this target exposure. More traditional usage would quantify beta relative to a factor. The equivalent of my developing markets beta, would be a beta of one to developing markets (as described by a benchmark).
Central Counterparty (CCP)
See Central counterparty for one of many definitions. This is a counterparty through which all parties to a transaction deal. Uptake of using a CCP is being driven by both market participants and regulators, as a credit, settlement and operational risk reduction strategy.
There is a move for more classes of transaction to be cleared centrally. Although simple in concept, the use of a central counterparty becomes complex as more types of trades, and a diverse set of users need to be accommodated. Central counterparties are the focus of much and growing attention. They will definitely become more important over time.
See Greeks below.
Refers to products which deliver a return that is proportional to the price of their underlying. In the case of many products, the underlying is a beta (as defined above). Simplistically, a delta one product based on an index will produce a similar return to the index. A delta one product based on a single share will produce a return similar to that of the underlying share. This return may be positive or negative. There are various technical definitions of delta one, including “products that can be perfectly hedged”, products with a “linear payoff” (as compared to options and other products which have nonlinear or contingent payoffs).
Without going into too much detail, these definitions are applicable in the main. Delta one also applies to activities which involve trading in delta one products or strategies. This includes marketmaking (definition below) of ETFs, futures, swaps and similar products, index arbitrage, repo and collateral trading. Refer to, Delta One – Wikipedia for a basic technical definition of delta one, and pointers to further information.
There is some controversy around Delta One which has given delta one products and practice a bad reputation. This is in part due to some of the recent large blow ups (including Kerviel, Adoboli and others) being in delta one trading businesses. Although somewhat incomplete, and simplistic, here is an article which illustrates some of the complexity and hype around delta one FT Alphaville » How ‘Delta One’ really works. Although factually correct, I urge readers to take the content with a grain of salt.
In defence, delta one products are not themselves dangerous. Only when used negligently, or without understanding, is delta one trading dangerous. Analogous is the use of an axe for chopping wood, or as a weapon. It is not the axe, but the user who determines the outcome.
Dodd Frank Act
From the act itself:
“To promote the financial stability of the United States by improving accountability
and transparency in the financial system, to end ‘‘too big to fail’’, to protect
the American taxpayer by ending bailouts, to protect consumers from abusive
financial services practices, and for other purposes,” Click here for the rest.
More relevant is the part of the Act which deals with regulation of Derivatives, and in particular swaps. Important is the classification of swaps as “swaps”, “security based swaps” and “mixed swaps”. Equity swaps, which are important in synthetic beta delivery fall into the second category. Click here for more information.
ETF – Exchange Traded Fund
Traditionally, ETFs are a class of exchange listed instruments which replicate an index. ETFs in various forms have been around since the late 1980’s. They have seen massive growth – especially in the USA – where approximately 30% of trading on US exchanges is attributed to ETFs.
There is a substantial amount of information on ETFs easily available. See for example:
or http://online.wsj.com/ad/focusonetfs/history.html. Also, the Blackrock Industry Review provides comprehensive coverage of the global ETF landscape. ETFs are seeing substantial growth, with many new and established providers delivering a broad range of products. They are used by both retail and institutional investors.
ETFs deliver a target beta. Over time, ETFs have evolved to cover more than just passive index replication. We see active ETFs, ETFs over an ever diversifying range of asset classes and factors, and inverse and leveraged ETFs.
Technically, various jurisdictions and regulators apply different definitions and structures around what can actually be called an ETF. Other similar products include ETCs (Exchange Traded Commodities and ETNs (Exchange Traded Notes). Although these all differ in their underlying structure, risk characteristic and regulatory treatment, they are all members of a class of listed beta deliverers.
On this website, I make no distinction between the various products, both jurisdictionally, and by specific ETxxx. See for example About Exchange Traded Funds (ETFs) and Exchange Traded Commodities (ETCs) – Australian Securities Exchange – ASX, or ESMA Consultation Document on CITS ETFs for more technical discussions from the Australian and European perspectives respectively.
Future of financial advice, an Australian Government initiative announced in 2011. FOFA is based around the delivery of financial advice to retail clients. A reaction to instances of conflict of interest between advisors, product providers and investors, FOFA focuses on transparency and disclosure.
In the past, there was little regulation in the way financial advisors could act. Frequently, product providers provided for generous one off and ongoing incentives, including reward for volume targets and ongoing (trailing) fees. Cases where investors were encouraged towards products – not on the merits of the product – but on the remuneration given to advisors have been documented. Although not all (or even a majority of) advisors practiced this way, investors and investor groups lost confidence in the services of advisors.
The reforms under FOFA outlaw certain types of product fees, and require transparency around what investors are being charged. They also put a framework around the engagement and ongoing relationship between financial advisors and their clients. These reforms were implemented in July 2012, and operate on a voluntary basis until they become compulsory in July 2013. The outcome will be a move towards a fee for service model, with a periodic renewal at the investor’s option.
In derivative trading, Greek letters are used to describe various parameters. Some of the common terms are described below (in my words). For a more comprehensive list, and technical definitions, see Greeks Definition | Investopedia.
Note Alpha and Beta are technically not part of the traditional family of Greeks associated with derivative trading. They have however become part of the jargon of the financial markets, and are used alongside the option Greeks.
- Delta – the sensitivity of the price of a derivative to changes in price of the underlying asset. For example, if the price of a share increases by 1.0%, and an option based on the share increases by 0.5%, then the option would have a delta of 0.5 or 50%.
- Gamma – the change in delta as the price of the underlying asset changes. This second order quantity is what distinguishes nonlinear (option type) derivatives from delta one derivatives. For the latter, gamma would be (very nearly) zero, whilst for options, gamma will vary with the price of the underlying.
- Theta – the change in price of an asset over time. Also referred to as time decay.
- Rho – the sensitivity of an asset to interest rates
The Australian Government Review into the Governence, Structure and Operation of Australia’s Superannuation System is a detailed report which came out of a comprehensive review of the superannuation system (referred to as the Cooper Review) http://www.supersystemreview.gov.au/. MySuper is a framework applied to superannuation contributions from individuals who do not actively choose how their contributions are directed.
MySuper is a default option, followed in the absence of any active choices, and will be available from July 2013. MySuper is designed as a diversified and cost effective (but not necessarily lowest cost) one stop product. Stronger Super is the Australian Government site, with information not only about mySuper, but the whole Australian superannuation system.
As an outcome, there is considerable attention being given to potential mySuper products, as in many plans, the majority of stakeholders tend not to make an active choice, hence their contributions will be invested in the mySuper option when it becomes available.
Self Managed Super Fund. This is an Australian construct, which refers to a superannuation fund run directly by and for a small group of beneficiaries (usually an individual, family or small group).
There is a legislative framework around how such funds operate (they are regulated by the Australian Prudential Regulation Authority (APRA)). Investment guidelines vary, but the majority of SMSFs tend to hold listed securities, direct property and cash. They are not, however, restricted exclusively to these asset classes or types of investments. Self-managed super | MoneySmart by ASIC, gives an overview of SMSFs and links to further information and resources. These pages from the Australian Taxation Office (ATO) give detail about SMSFs Self-managed super fund statistical report – March 2011.
Undertaking for Collective Investment in Transferable Securities. This is a set of directives which applies to collective investment schemes. These include listed and unlisted funds and securities.
With some nuances, UCITS is a widely accepted framework across the EU, and is also (on a de-facto basis) accepted in many non EU jurisdictions. Most European ETFs are UCITS compliant, which is rightly or wrongly seen as a stamp of legitimacy.
UCITS does impose conditions on how a fund is constructed, what instruments it can hold, how it must track a benchmark or follow a mandate, the use of derivatives, leverage and more. Both synthetic and physical replication are permitted under UCITS. See Investment Funds – European Commission for source material. More user friendly definitions can also be found with simple web searches.