A-Z of investing
Absolute volatility is the amount of risk or uncertainty in the changes of an investment's value. Generally, the higher the volatility, the higher the risk as the price of a security can change more dramatically in either direction. Volatility is usually measured by the standard deviation of asset price movements.
Alternative investments tend to be represented by investments in private equity, infrastructure and hedge funds; while traditional investments are often comprised of publicly traded equities, fixed income securities, cash, and real estate.
Asset mix is the categorization of assets within the pension plan portfolio (e.g. cash, Canadian equities, real estate, etc.). Each category is measured as a percentage of the total pension plan portfolio's fair value.
Assumptions are estimates of what certain variables – such as interest rates, investment returns, and mortality rates – will be in the future. Assumptions are used to estimate the future cost of pensions and the future value of pension assets.
Benchmark is a standard to which the performance of an investment is measured. Generally, broad market or market-segment stock and bond indexes are used as benchmarks (e.g., TSX, DEX Universe, etc.).
Capital preservation prevents capital losses during down market conditions. A capital preservation investment approach generally implies a lower-level risk profile for the investment portfolio; this may result in relative underperformance during periods of rising markets. However, it is expected to result in outpacing benchmarks during periods of steep market decline.
Credit spreads refers to the difference in yield between a risky bond (e.g., corporate bond) and a high quality bond (e.g., Government of Canada bond) that have the same payment date. Typically, an issuer of bonds with greater credit spreads implies a higher probability of potential default on debt repayment, and investors have to earn a higher yield to protect against the risk exposure.
Derivative overlays are derivative securities (e.g., equity futures) used to cost-effectively modify the overall total Plan economic exposures without disrupting the underlying direct investing activities of investment managers.
Diversification is a risk management strategy that consists of holding a variety of different (lowly correlated) investments within a portfolio. The objective is to reduce volatility in the plan and achieve more efficient risk adjusted returns.
Emerging markets represent countries (such as Brazil, China and India) experiencing higher economic and industrialized growth than developed countries (such as U.S., Canada and U.K.). Emerging markets often present higher investment risks due to geopolitical instabilities, currency fluctuations, and financial regulations still in infancy; on the other hand, emerging markets offer investors expected higher returns because of greater growth prospects.
Frontier markets - have lower market capitalization and liquidity than emerging markets, which are more developed. Frontier markets offer higher long-term returns to compensate for incremental risks and volatility.
Fundamental research investing allows for business valuations that are based on qualitative and quantitative assessments of such things as debt levels, stability of growth of free cash flows, quality of management, and relative industry and economic analysis. Fundamental research does not look at trading patterns or investor behaviour to analyze investment opportunities.
Funded status is a measure of the amount of assets the pension plan currently holds to pay out its future pension benefits (present value of projected future pension benefits). The funded status is regarded as the "health check" of a pension plan, and is determined by undertaking a funding valuation of the pension plan.
Funding valuation is an annual assessment of the liabilities (present value of current and projected future pension benefits) a pension plan must pay out, and the assets the pension plan holds to pay out pension benefits. It takes into account a number of demographic and long-term economic assumptions that include inflation and interest rates, plan member mortality rates, salary increases, etc. The assumptions used in a funding valuation are generally reviewed and adjusted from year-to-year.
Infrastructure is an asset class within the investment portfolio that consists of investments in the physical systems of a region such as toll roads, bridges, pipelines, etc., that generate a long and steady cash flow.
Investment horizon is the length of time an investment is held before payout is expected. It takes into account the amount and timing of the expected payout, and it influences investment strategy. For a pension plan like the PSPP, the focus is on the long term.
Investment portfolio is a group of financial assets.
Investment risk is the uncertainty of asset returns associated with investing activities (i.e., asset returns are lower than what is expected).
J-curve – the historical tendency of certain investments to produce negative returns in their early years.
Long bond – the generic term for bonds that mature relatively far in the future – typically 10 years or more, but extending up to 50 years in some cases. Long bonds are attractive investment options for defined benefit pension plans, because the extended maturity dates tend to align well with the long-term nature of pension liabilities.
Private debt is debt investment available to a limited number of accredited investors such as the PSPP, and does not have the usual registration obligations that is required for public offerings.
Private equity is equity capital of non-public companies. Private equity is less liquid and is considered more of a long term investment.
Private markets is the market for assets that are not sold or listed on a public exchange, such as a stock exchange. Assets bought and sold in the private market include things like real estate, private equity, infrastructure, and mortgages.
Public equity is an ownership interest in a company that sells shares on a public stock exchange.
Public investment is equity stakes or debt investments in public companies.
Public markets is the market for assets that are bought and sold on public exchanges, such as stock exchanges.
Required rate of return is the rate of return on investment that is needed to fully fund or generate sufficient amount of assets to pay the liabilities (present value of current and projected future pension benefits) of a pension plan. It is determined by the results of the funding valuation.
Special Debentures are fixed income securities (i.e., bonds) that were issued to the Plan by the Province of Ontario as an initial funding mechanism when the PSPP was established as a separately funded plan in 1990.
Specialty mandates – created when a portion of the money in a particular asset class is invested in a specific segment of the market. Examples of mandates created by OPB include: a small cap Canadian equity mandate, a high-yield U.S. equity mandate, a gold mandate, and a distressed debt mandate.
Strategic asset allocation (SAA) is a long-term discipline of asset mix with the purpose of achieving highest returns on investment to meet current and projected future pension benefits given the Plan's risk tolerance and investment horizon.
Tactical allocation (TAA) is an asset mix strategy that uses both fundamental and quantitative factors in a systematic approach to increase or decrease OPB's risk exposure at various points in market cycles to take advantage of investment opportunities.
Universe bond – a portfolio of bonds with general characteristics that reflect the overall Canadian bond market. With thousands of corporate, government and other bond issues circulating at any one time, the investment industry has accepted this "Universe" as a representation of the broader bond market. The portfolio also forms the basis for the commonly used FTSE/TMX Universe Bond Index.
Unrewarded risk is an investment risk that is not associated with any benefit for the party accepting the risk. It does not generate sufficient returns to make it a rational risk for investors to take.
Vintage year – refers to the year in which an investor makes its first investment in a portfolio company or, for a fund investment, the year in which the fund makes its first of several investments.