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Active Premium
A measure of the Investment's annualized return minus the Benchmark's annualized return.
Active Premium = Investment's annualized return - Benchmark's annualized return.
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Alpha
Alpha is a measure of value added. It is the Y intercept of the regression line. Alpha measures the difference between a fund's actual returns and its expected performance, given its level of risk (as measured by beta). A positive alpha figure indicates the fund has performed better than its beta would predict. In contrast, a negative alpha indicates a fund has underperformed, given the expectations established by the fund's beta. Some investors see alpha as a measurement of the value added or subtracted by a fund's manager. There are limitations to alpha's ability to accurately depict a manager's added or subtracted value. In some cases, a negative alpha can result from the expenses that are present in the fund figures but are not present in the figures of the comparison index. Alpha is dependent on the accuracy of beta: If the investor accepts beta as a conclusive definition of risk, a positive alpha would be a conclusive indicator of good fund performance. Of course, the value of beta is dependent on another statistic, known as R-squared.
Alpha = M RD - Beta A' M R
Annualized Alpha : Annualized Alpha is the annualized value of Alpha.
Annualized Alpha = ((1 + Alpha)12 - 1 (Monthly Data))
Annualized Alpha = ((1 + Alpha)4 - 1 (Quarterly Data))
Average Gain (Gain Mean)
This is a simple average (arithmetic mean) of the periods with a gain. It is calculated by summing the returns for gain periods (return > 0) and then dividing the total by the number of gain periods.
Average Loss (Loss Mean)
This is a simple average (arithmetic mean) of the periods with a loss. It is calculated by summing the returns for loss periods (return < 0) and then dividing the total by the number of loss periods.
Average Return (Mean)
This is a simple average return (arithmetic mean) which is calculated by summing the returns for each period and dividing the total by the number of periods. The simple average does not take the compounding effect of investment returns into account.
Beta
Beta is the slope of the regression line. Beta measures the risk of a particular investment relative to the market as a whole (the market can be any index or investment you specify). It describes the sensitivity of the investment to broad market movements.
Beta is a risk metric employed primarily in the equity markets. It measures the systematic risk of a single instrument or an entire portfolio. William Sharpe (1964) first used the notion in his landmark paper introducing the capital asset pricing model (CAPM). The name "beta" was applied later.
Beta describes the sensitivity of an instrument or portfolio to broad market movements. The stock market (represented by an index such as the S&P 500 or FT-100) is assigned a beta of 1.0. By comparison, a portfolio (or instrument) which has a beta of 0.5 will tend to participate in broad market moves, but only half as much as the market overall. A portfolio (or instrument) with a beta of 2.0 will tend to benefit or suffer from broad market moves twice as much as the market overall.
N N
Beta = (S (R I - M R ) (RD I - M RD) ) A, (S (R I - M R ) 2 )
I=1 I=1
Calmar Ratio
This is a return/risk ratio. Return (numerator) is defined as the Compound Annualized Rate of Return over the last 3 years. Risk (denominator) is defined as the Maximum Drawdown over the last 3 years. If three years of data are not available, the available data is used. ABS is the Absolute Value.
Calmar Ratio = Compound Annualized ROR A, ABS (Maximum Drawdown)
Compound (Geometric) Average Return
The geometric mean is the monthly average return that assumes the same rate of return every period to arrive at the equivalent compound growth rate reflected in the actual return data. In other words, the geometric mean is the monthly average return that, if applied each period, would give you a final Vami (growth) index that is equivalent to the actual final Vami index for the return stream you are considering.
Convertible Bond
A corporate bond issued with a corporate bond yield and a conversion feature that allows the holder to convert the bond into a fixed number of shares of the issuing company's common stock.
Correlation and Correlation Coefficient
Correlation measures the extent of linear association of two variables. The Coefficient of Determination ( R2 ) is a measure of how well the regression line fits the data (variation explained by the regression line). Unexplained variation is simply 1- R2.
Derivative
A financial instrument whose performance is linked to a specific security index or financial instrument. Typically derivatives are used to transfer risk or negotiate the future sale or delivery of an investment. Derivative instruments come in four basic forms: forward contracts, futures contracts, swaps and options.
The Down Capture Ratio
A measure of the Investment's compound return when the Benchmark was down divided by the Benchmark's compound return when the Benchmark was down. The smaller the value the better.
Down %
The Down Percentage Ratio is a measure of the number of periods that the Investment outperformed the Benchmark when the Benchmark was down, divided by the number of periods that the benchmark was down. The larger the ratio, the better.
Down #
The Down Number Ratio is a measure of the number of periods that the Investment was down when the Benchmark was down, divided by the number of periods that the Benchmark was down. The smaller the ratio, the better.
Downside Deviation
Similar to the loss standard deviation except the downside deviation considers only returns that fall below a defined Minimum Acceptable Return (MAR) rather then the arithmetic mean. For example, if the MAR is assumed to be 10%, the downside deviation would measure the variation of each period that falls below 10%. (The loss standard deviation, on the other hand, would take only losing periods, calculate an average return for the losing periods, and then measure the variation between each losing return and the losing return average).
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Drawdown
A Drawdown is any losing period during an investment record. It is defined as the percent retrenchment from an equity peak to an equity valley. A Drawdown is in effect from the time an equity retrenchment begins until a new equity high is reached. (i.e. In terms of time, a drawdown encompasses both the period from equity peak to equity valley (Length) and the time from the equity valley to a new equity high (Recovery).
Maximum Drawdown is simply the largest percentage drawdown that has occurred in any investment data record.
Event Risk
The likelihood that an investment's value will change as the result of unexpected events, such as corporate restructurings, takeovers, regulatory shifts or disasters.
Gain Standard Deviation
Similar to standard deviation, except this statistic calculates an average (mean) return for only the periods with a gain and then measures the variation of only the gain periods around this gain mean. This statistic measures the volatility of upside performance.
Gain to Loss Ratio
This is a simple ratio of the average gain in a gain period divided by the average loss in a losing period. Periods can be monthly or quarterly depending on the data frequency.
Gain/Loss Ratio = ABS (Average Gain in Gain Period A, Average Loss in Loss Period)
Gross Market Exposure
The exposures often exceed 100% because they do not account for the use of leverage.
Information Ratio
The Information Ratio is the Active Premium divided by the Tracking Error. This measure explicitly relates the degree by which an Investment has beaten the Benchmark to the consistency by which the Investment has beaten the Benchmark.
Information Ratio = Active Premium / Tracking Error
Jensen Alpha
The Jensen Alpha, developed by Michael Jensen, quantifies the extent to which an investment has added value relative to a benchmark. The Jensen Alpha is equal to the Investment's average return in excess of the risk free rate minus the Beta times the Benchmark's average return in excess of the risk free rate.
Leverage
The practice of borrowing to add to an investment position when one believes that the return from the position will exceed the cost of the borrowed funds.
Liquidity risk
Is financial risk due to uncertain liquidity. An institution might lose liquidity if its credit rating falls, it experiences sudden unexpected cash outflows or some other event causes counterparties to avoid trading with or lending to the institution. A firm is also exposed to liquidity risk if markets on which it depends are subject to loss of liquidity.
Liquidity risk tends to compound other risks. If a trading organization has a position in an illiquid asset its limited ability to liquidate that position at short notice will compound its market risk. Suppose a firm has offsetting cash flows with two different counterparties on a given day. If the counterparty that owes it a payment defaults the firm will have to raise cash from other sources to make its payment. Should it be unable to do so, it too would default. Here, liquidity risk is compounding credit risk.
Obviously, a position can be hedged against market risk but still entail liquidity risk. This is true in the above credit risk example:the two payments are offsetting so they entail credit risk but not market risk.
Loss Standard Deviation
Similar to standard deviation except this statistic calculates an average (mean) return for only the periods with a loss and then measures the variation of only the losing periods around this loss mean. This statistic measures the volatility of downside performance.
Losing Streak
The percentage change between the maximum equity high (high water mark) and the latest month's equity. If the latest month's equity is a high water mark then 0% is displayed. This statistic displays the percentage a manager needs to overcome in order to start accruing any fees based on a high water mark.
Mark to Market
To determine the price one can get today for currently owned securities according to current market valuations.
Market Exposure
The amount of portfolio that is exposed to market risk because it is not matched by an offsetting position.
Market Inefficiencies
Pricing disparities caused by a lack of information about a market or company or by a distortion of the information available.
Market Neutral Portfolio
A portfolio composed of equal dollar amounts of long stock positions and offsetting short stock positions (long or short any security).
Market Exposure = Long Exposure : Short Exposure
Capital
Net Market Exposure
The percentage of the portfolio exposed to market risk because the long positions are not matched by equal dollar amounts of short positions.
Offshore fund
An investment vehicle that is domiciled outside the U.S. and has no limit on the number of non-U.S. investors it can take on. Although the fund's securities transactions can occur on U.S. exchanges and can be executed by a U.S. manager, or general partner, its administration and audits are conducted offshore:usually in a tax haven like the Cayman Islands. Because it is administered outside the U.S., non-U.S. investors and such U.S. investors such as pension funds and other tax-exempt entities are not subject to U.S. taxes.
Option
A contract that gives parties the right to buy, or sell, a specific asset or security at a specified strike price by a pre-set date. It falls under the derivates category and comes in the form of calls (option to buy) and puts (option to sell). The cost of an option is generally a fraction of the cost of its underlying security.
Regulation D
A provision in the Securities Act of 1933 that allows privately placed transactions to take place without SEC registration and prohibits hedge funds from advertising themselves to the general public. It also outlines which parties qualify as company insiders.
Risk-free rate
The theoretical return on a risk-free investment, usually a U.S. government short term security.
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Sharpe Ratio
A return/risk measure developed by William Sharpe. Return (numerator) is defined as the incremental average return of an investment over the risk free rate. Risk (denominator) is defined as the standard deviation of the investment returns.
The higher the ratio, the better the return per unit of risk taken. It is calculated by subtracting the risk-free rate from the fund's annualized average return and dividing the result by the fund's annualized standard deviation. A Sharpe ratio of 1:1 indicates that the rate of return is proportional to the risk assumed in seeking that reward. Developed by Prof. William R. Sharpe of Stanford University.
Where R I = Return for period I
Where M R = Mean of return set R
Where N = Number of Periods
Where SD = Period Standard Deviation
Where R RF = Period Risk Free Return
N
M R = ( S R I ) A, N
I=1
N
SD = ( S ( R I - M R ) 2 A, (N - 1) ) AŤ
I = 1
Sharpe Ratio = ( M R - R RF ) A, SD
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Short selling
The practice of borrowing a stock on collateral and immediately selling it on the market with the intention of buying it back later at a lower price.
Sortino Ratio
This is another return/risk ratio developed by Frank Sortino. Return (numerator) is defined as the incremental compound average period return over a Minimum Acceptable Return (MAR). Risk (denominator) is defined as the Downside Deviation below a Minimum Acceptable Return (MAR).
Spread
The difference between the prices of two comparable or related securities. Spreads are measured in basis points. One basis point equals 1/100 of a percent. For example, corporate bonds of a comparable maturity and comparable coupon rates will have higher yields than treasuries to reflect greater default risk, so their yields are often quoted as a spread above the Treasury rate. The more risky the bond issue, the larger is the spread.
Standard Deviation
Standard Deviation measures the dispersal or uncertainty in a random variable (in this case, investment returns). It measures the degree of variation of returns around the mean (average) return. The higher the volatility of the investment returns, the higher the standard deviation will be. For this reason, standard deviation is often used as a measure of investment risk.
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Sterling Ratio
This is a return/risk ratio. Return (numerator) is defined as the Compound Annualized Rate of Return over the last 3 years. Risk (denominator) is defined as the Average Yearly Maximum Drawdown over the last 3 years less an arbitrary 10%. To calculate this average yearly drawdown, the latest 3 years (36 months) is divided into 3 separate 12-month periods and the maximum drawdown is calculated for each. Then these 3 drawdowns are averaged to produce the Average Yearly Maximum Drawdown for the 3 year period. If three years of data are not available, the available data is used.
Sterling Ratio = Compound Annualized ROR A, ABS ( (Average Drawdown - 10% ))
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Swap contract
An agreement by two or more parties to exchange currencies, commodities, interest payments, investment returns or cash flows, either presently or at a future date. Swaps are a form of derivatives. Interest-rate swaps, which are used to convert a fixed-rate investment into a floating :rate instrument, and vice versa, is the most common example of a swap. Credit-default swaps and rate-of-return swaps are used to ensure specific returns on investments, with the swap counterparty assuming the risk.
Systematic or market risk
Exposure to uncertainty about systematic rises and falls in stock market prices that affect the prices of all stocks in a market or sector.
Tracking Error (Annualized)
Tracking Error is a measure of the unexplained portion of an investments performance relative to a benchmark. Annualized Tracking Error is measured by taking the square root of the average of the squared deviations between the investment's returns and the benchmark's returns, then multiplying the result by the square root of 12.
Traditional Investments
Products whose performances closely track the broader stock and bond markets.
Treynor Ratio
The Treynor Ratio, developed by Jack Treynor, is similar to the Sharpe Ratio, except that it uses Beta as the volatility measurement. Return (numerator) is defined as the incremental average return of an investment over the risk free rate. Risk (denominator) is defined as the Beta of the investment returns relative to a benchmark.
Up Capture
The Up Capture Ratio is a measure of the Investment's compound return when the Benchmark was up divided by the Benchmark's compound return when the Benchmark was up. The greater the value, the better.
Up %
The Up Percentage Ratio is a measure of the number of periods that the Investment outperformed the Benchmark when the Benchmark was up, divided by the number of periods that the benchmark was up. The larger the ratio, the better.
Up #
The Up Number Ratio is a measure of the number of periods that the Investment was up, when the Benchmark was up, divided by the number of periods that the Benchmark was up. The larger the ratio, the better.
Value Added Monthly Index (VAMI)
This index reflects the growth of a hypothetical $1,000 in a given investment over time. The index is equal to $1,000 at inception. Subsequent month-end values are calculated by multiplying the previous month's VAMI index by 1 plus the current month rate of return.
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Value at Risk (VaR)
VaR is a category of risk metrics that describe probabilistically the market risk of a trading portfolio. Value-at-risk is widely used by banks, securities firms, commodity merchants, energy merchants and other trading organizations. Such firms could track their portfolios' market risk by using historical volatility as a risk metric. They might do so by calculating the historical volatility of their portfolio's market value over a rolling 100 trading days. The problem with doing this is that it provides a retrospective indication of risk. The historical volatility would illustrate how risky the portfolio had been over the previous 100 days. It would say nothing about how much market risk the portfolio was taking today.
For institutions to manage risk, they must know about risks while they are being taken. If a trader mis-hedges a portfolio, his employer needs to find out before a loss is incurred. Value-at-risk gives institutions the ability to do so. Unlike retrospective risk metrics, such as historical volatility, value-at-risk is prospective. It quantifies market risk while it is being taken.
Warrant
The stock conversion component of a convertible bond
Yield
The single investment rate that sets the present value of all of a bond's future cash payments equal to the price of the bond.
$ Profit to Loss Ratio
This ratio combines the Gain to Loss Ratio with the ratio of the percentage of profitable periods to the percentage of losing periods. Since this ratio considers both the average size and the frequency of winning and losing periods, it tells you the historical ratio of dollars earned in the investment to dollars lost. For example, a $ Profit to Loss Ratio of 2.5 means that, historically, the investment earned $2.50 of profit for each $1.00 of risk taken.
$ Profit/Loss Ratio = (% Profitable Periods A, % Losing Periods) A' Gain to Loss Ratio
% Gain
The Percent Gain Ratio is a measure of the number of periods that the Investment was up divided by the number of periods that the Benchmark was up. The larger the ratio, the better.
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