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Liquid Alternatives Glossary

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A guide to common liquid alternatives investing terms

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    ABSOLUTE RETURN

    Performance generated using the risk-free rate as a starting point rather than the returns of an index like the S&P 500. 

     

    ABSOLUTE RETURN CURRENCY     

    An investment strategy which takes long and short positions in various global currencies, as opposed to strategies which take primarily long foreign currency and short US dollar/home currency position.       

     

     

    ACTIVE MANAGEMENT

    An investment strategy that does not seek to closely track a specific benchmark index.

     

    ALPHA

    Measures the difference between a portfolio’s actual returns and its expected returns given its risk level as measured by its beta. A higher alpha is better, but a high alpha is only reliable in the presence of a high R-squared value. It can be viewed as a risk-adjusted measure of return. Some advisors see alpha as a measurement of the value added or subtracted by a fund’s manager. A positive alpha figure indicates the portfolio has performed better than its beta would predict. A negative alpha figure indicates a portfolio has underperformed, given the expectations established by the fund’s beta.             

     

    ALTERNATIVE INVESTMENTS

    Broadly defined, an investment that is not one of the three traditional asset types (stocks, bonds and cash). Alternative investment strategies typically have the ability to use leverage, shorting, and active risk management in pursuit of returns that are lowly correlated with traditional asset types.

     

    ARBITRAGE

    See Relative Value.

     

    ASSET ALLOCATION

    An investment strategy that seeks to balance risk and reward by dividing investments among different kinds of asset classes, such as stocks, bonds and cash.

     

    ASSET CLASS

    A group of securities that share similar characteristics and behave similarly in the marketplace. Asset classes are generally governed by the same rules and regulations.

                            

    B

    BACKFILL BIAS

    An effect that can make an index or category average performance better than the actual experience of a hedge fund or mutual fund investor. Backfill bias happens when a fund chooses to report to a data base sometime after inception, and the data provider allows the past history of the fund to be incorporated into the indices.

     

    BEAR EQUITY MARKET

    A period in which major stock market indices fall.

     

    BEAR MARKET MORNINGSTAR CATEGORY

    A Morningstar alternative category. According to Morningstar Inc.’s methodology document, http://corporate.morningstar.com/us/documents/MethodologyDocuments/ MethodologyPapers/MorningstarCategory_Classifications.pdf: These funds dedicate a majority of the fund’s assets to equities. Most of the portfolio is dedicated to short stock positions in an attempt to take advantage of anticipated market or stock declines producing a net exposure to equities of less than or equal to negative 20%. Some managers invest the proceeds from their short positions in low-risk assets, while others dedicate a portion to long stock positions in order to hedge against broad market rallies. In the event of a broad market rally, these funds will lose money on their short positions but will experience a gain on their long positions. Short positions typically account for 60% to 85% of fund active exposure, although some funds may be 100% short after excluding regulatory collateral. These funds will typically have a beta of less than negative 0.3 to equity indices such as the S&P 500 or MSCI World.

     

    BENCHMARK

    The standard used as a point of reference for evaluting performance of a Fund.

     

    BETA

    A measure of the sensitivity of a security’s or portfolio’s returns to market moves; incorporates both the direction and magnitude of the response. If a portfolio has a beta of >1, it is more volatile than the benchmark. Conversely, if a portfolio has a beta <1, it is less volatile than the benchmark. If a portfolio has a positive beta, it tends to move in the same direction as the benchmark. Conversely, if a portfolio has a negative beta, it tends to move in the opposite direction as the benchmark.

     

    BONDS

    A debt investment whereby investors loan money to entities (i.e. a corporation or government) to help them finance a variety of projects and activities. The entity borrows funds for a defined period of time at a particular interest rate. Types of bonds include corporate, municipal and U.S Treasury notes, bills and bonds, known as Treasuries.

     

    BOTTOM-UP

    An investment strategy that starts by selecting individual securities, rather than countries or sectors.

     

    BULL EQUITY MARKET

    A period in which major stock market indices rise.

     

    C

    CONCENTRATION

    The percentage of a fund invested in a single issuer or type of security.

     

    CONVERTIBLE ARBITRAGE

    A strategy that generally takes long positions in convertible bonds and short positions in the stock of the same issuer.

     

    CORPORATE EVENTS

    Significant changes in publicly traded corporations, such as mergers, acquisitions, spin offs, restructurings, recapitalizations, bankruptcies, and changes in management.

     

    CORRELATION

    A measure of the extent to which two or more variables fluctuate together; can be used to indicate the likelihood of a directional relationship between securities, portfolios, or asset classes.

     

    COUNTERTREND

    A systematic trading strategy that attempts to profit from lack of longer-term price trends or price trend reversals.

     

    CREDIT RISK

    The risk that a borrower will default on a debt.

     

    CREDIT SPREAD

    The difference in yield between two debt instruments of similar maturity but different credit quality.

     

    D

    DERIVATIVE

    A security whose price is dependent upon or derived from one or more underlying assets. The most common underlying assets include stocks, bonds, commodities, currencies, interest rates and market indexes. Futures contracts, forward contracts, options and swaps are the most common types of derivatives.

     

    DIRECTIONAL

    A way to describe a position in a portfolio; long or short positions, viewed independently.

     

    DISCRETIONARY

    Sourced primarily from a manager’s knowledge.

     

    DISPERSION

    A measure of the range of performance results across securities, funds, etc.

     

    DRAWDOWN

    The peak-to-trough decline of an investment.

     

    DURATION

    A measure of a bond’s price sensitivity to a change in interest rates.

     

    E

    EQUITY MARKET NEUTRAL

    Strategies that match long stocks with short stocks in order to reduce most of the portfolio’s systematic or broad market risk.

     

    EXPENSE RATIO - GROSS

    The total of a mutual fund's annual fund operating expenses (assuming no expense reductions), expressed as a percentage of the fund's average net assets.

     

    EXPENSE RATIO - NET

    Represents a mutual fund's annual fund operating expenses (excluding fee waivers and reimbursements), expressed as a percentage of the fund's average net assets.

     

    EVENT DRIVEN

    An investment strategy that seeks profit from company events, such as mergers or bankruptcies. Also a GSAM Liquid Alternative Investment Peer Group category as defined by GSAM.

     

    EQUITY LONG/SHORT

    An investment strategy that selects stocks to potentially profit from both rising and falling stock prices. Also a GSAM Liquid Alternative Investment Peer Group category as defined by GSAM.

     

    F

    FUNDAMENTAL

    An investment process that attempts to value securities based on fundamental analysis, whereby research using economic, financial, qualitative and quantitative factors is employed to select investments. Fundamental analysis seeks to take a holistic view of factors that may impact the value of a security (e.g., economic and sector conditions) and individually specific factors (e.g., company management).

     

    G

    GLOBAL MACRO

    Strategies that take directional long and short positions across all asset classes.

     

    GTAA

    An acronym for Global Tactical Asset Allocation, which is a long-only (see definition for long-only), global macro strategy (see definition for Global Macro).

     

    H

    HEDGE

    Establishing a position to reduce the risk of adverse price movements in a strategy.


    HEDGE FUND

    Private, pooled investment vehicles that are offered via private placement to qualified investors, including certain high net worth individuals and institutional investors.

     

    HEDGE FUND REPLICATION

    A quantitative strategy that seeks to mimic the returns of a hedge fund index.


    HEDGE FUND STYLE PREMIA

    A quantitative strategy that seeks to mimic the returns of hedge fund factors, which are distinct attributes of a portfolio which are deemed responsible for returns, such as value, momentum or size.

     

    HIGH YIELD (OR JUNK) BOND

    Lowly rated bonds with ratings below “BBB” from S&P and below “Baa” from Moody’s. Yields are usually higher for junk bonds because of the higher default risk of the issuers.

     

    I

    ILLIQUID INVESTMENT

    As defined by the Investment Company Act of 1940, investments that cannot be sold or disposed of in the ordinary course of business within seven days at approximately the price at which the fund has valued the investment on its books.

     

    ILLIQUIDITY

    The inability to quickly convert a security or asset into cash without incurring a large loss.

     

    J

    JUNK

    See high yield.

     

    L

    LEVERAGE

    The use of financial instruments or borrowed capital, in excess of the original investment’s value, to increase the potential risk and return of an investment.

     

    LIQUIDITY

    An asset’s ability to be easily converted through an act of buying or selling without causing a significant movement in the price and with minimum loss of value.

     

    LONG-ONLY

    Investments that do not employ shorting. See definition for Shorting.

     

    LONG/SHORT

    The buying of a security with the expectation that the asset will rise in value, combined with the selling of a borrowed security with the expectation that the asset will fall in value.

     

    LONG/SHORT CREDIT

    The buying of a security with credit risk—a long bond or short credit default swap, for example—with the expectation that the asset will rise in value, combined with the selling of a security with credit risk—a short bond or long credit default swap, for example—with the expectation that the asset will fall in value.

     

    LONG/SHORT EQUITY MORNINGSTAR CATEGORY

    A Morningstar alternative category. According to Morningstar Inc.’s methodology document, http://corporate.morningstar.com/us/documents/ MethodologyDocuments/MethodologyPapers/MorningstarCategory_Classifications.pdf, long/short portfolios hold sizable stakes in both long and short positions in equities and related derivatives. Some funds that fall into this category will shift their exposure to long and short positions depending on their macro outlook or the opportunities they uncover through bottom-up research. Some funds may simply hedge long stock positions through exchange-traded funds or derivatives. At least 75% of the assets are in equity securities or derivatives.

     

    M

    MANAGED FUTURES MORNINGSTAR CATEGORY

    A trading strategy that utilizes futures and option contracts to gain exposure to financial instruments; trading programs can generally be classified as either technical or fundamental; managers are often referred to as “Trend Followers” or “Momentum Traders”; generally operated by CTAs (Commodity Trading Advisors) or CPOs (Commodity Pool Operators). Also a Morningstar alternative category. According to Morningstar Inc.’s methodology document, http://corporate.morningstar.com/us/documents/MethodologyDocuments/MethodologyPapers/MorningstarCategory_Classifications.pdf, these funds primarily trade liquid global futures, options, swaps, and foreign exchange contracts, both listed and over-the-counter. A majority of these funds follow trend-following, price-momentum strategies. Other strategies included in this category are systematic mean reversion, discretionary global macro strategies, commodity index tracking, and other futures strategies. More than 60% of the fund’s exposure is invested through derivative securities. These funds obtain exposure primarily through derivatives; the holdings are largely cash instruments.

     

    MARKET EXPOSURE

    A financial term which measures the proportion of money invested in the same industry sector. For example, a stock portfolio with a total worth of $500,000, with $100,000 in semiconductor industry stocks, would have a 20% exposure in "chip" stocks.

     

    MARKET NEUTRAL MORNINGSTAR CATEGORY

    A Morningstar alternative category. According to Morningstar Inc.’s methodology document, http://corporate.morningstar.com/us/documents/ MethodologyDocuments/MethodologyPapers/MorningstarCategory_Classifications.pdf, these funds attempt to reduce systematic risk created by factors such as exposures to sectors, market-cap ranges, investment styles, currencies, and/or countries. They try to achieve this by matching short positions within each area against long positions. These strategies are often managed as beta-neutral, dollar-neutral, or sector-neutral. A distinguishing feature of funds in this category is that they typically have low beta exposures (< 0.3 in absolute value) to market indices such as MSCI World. In attempting to reduce systematic risk, these funds put the emphasis on issue selection, with profits dependent on their ability to sell short and buy long the correct securities.

     

    MEDIAN

    The middle value in a consecutive series.

     

    MERGER ARBITRAGE

    The strategy of buying the stock of a target company and shorting the stock of the acquirer.

     

    MULTIALTERNATIVE MORNINGSTAR CATEGORY

    A Morningstar alternative category. According to Morningstar Inc.’s methodology document, http://corporate.morningstar.com/us/documents/MethodologyDocuments/MethodologyPapers/MorningstarCategory_Classifications.pdf, these funds offer investors exposure to several different alternative investment tactics. Funds in this category have a majority of their assets exposed to alternative strategies. An investor’s exposure to different tactics may change slightly over time in response to market movements. Funds in this category include both funds with static allocations to alternative strategies and funds tactically allocating among alternative strategies and asset classes. The gross short exposure is greater than 20%.

     

    MULTI-ASSET

    An investment strategy that invests in more than one of the four asset classes (equities, fixed income, currencies, and commodities).

     

    MULTICURRENCY MORNINGSTAR CATEGORY

    A Morningstar alternative category. According to Morningstar Inc.’s methodology document, http://corporate.morningstar.com/us/documents/MethodologyDocuments/MethodologyPapers/MorningstarCategory_Classifications.pdf, currency portfolios invest in multiple currencies through the use of short-term money market instruments; derivative instruments including and not limited to forward currency contracts, index swaps, and options; and cash deposits.

     

    MULTISTRATEGY

    Funds employing more than one of the GSAM Liquid Alternative Investments Peer Group strategies, as defined by GSAM (Equity Long/Short, Event Driven, Relative Value, Tactical Trading/Macro).

     

    MUTUAL FUND

    Public, pooled investment vehicles that are registered under the Investment Company Act of 1940 (in the U.S.) and open-ended (i.e., additional shares may be issued).

     

    N

    NAV (NET ASSET VALUE)

    The market value of one share of the Fund. This amount is derived by dividing the total value of all the securities in the fund’s portfolio, less any liabilities, by the number of fund shares outstanding.

     

    NET ASSETS

    Calculated as total assets less total liabilities of a mutual fund, as reported in the annual and semi-annual reports.

     

    NET EXPOSURE

    Calculated as long exposure less absolute value of short exposure of underlying investments in a fund; one indication of the market risk a strategy employs.

     

    NONTRADITIONAL BOND MORNINGSTAR CATEGORY

    A Morningstar category. According to Morningstar Inc.’s methodology document, http://corporate.morningstar.com/us/documents/ MethodologyDocuments/MethodologyPapers/MorningstarCategory_Classifications.pdf, the Nontraditional Bond category contains funds that pursue strategies divergent in one or more ways from conventional practice in the broader bond-fund universe. Many funds in this group describe themselves as “absolute return” portfolios, which seek to avoid losses and produce returns uncorrelated with the overall bond market; they employ a variety of methods to achieve those aims. Another large subset are self-described “unconstrained” portfolios that have more flexibility to invest tactically across a wide swath of individual sectors, including high-yield and foreign debt, and typically with very large allocations. Funds in the latter group typically have broad freedom to manage interest-rate sensitivity, but attempt to tactically manage those exposures in order to minimize volatility. The category is also home to a subset of portfolios that attempt to minimize volatility by maintaining short or ultra-short duration portfolios, but explicitly court significant credit and foreign bond market risk in order to generate high returns. Funds within this category often will use credit default swaps and other fixed income derivatives to a significant level within their portfolios.

     

    NOTIONAL SHORT EXPOSURE

    The total short market exposure of a specific holding or a portfolio, including the inherent leverage of derivatives, derived from annual and semi-annual report data.

     

    O

    OPTION

    A privilege, sold by one party to another, that gives the buyer the right, but not the obligation, to buy (call) or sell (put) a stock at an agreed-upon price within a certain period or on a specific date.

     

    Q

    QUANTITATIVE

    An investment process that primarily uses computer models to select portfolio holdings.

     

    R

    RELATIVE VALUE

    An investment strategy that seeks to profit from the underpricing and overpricing of related investments. Also a GSAM Liquid Alternative Investment Peer Group category as defined by GSAM.

     

    RISK-FREE RATE

    The theoretical rate of return of an investment with zero risk; the rate represents the interest an investor would expect from a risk-free investment over a specific time period; US Treasury securities are often used as a proxy for risk-free investing.

     

    RISK PARITY

    An investment strategy that seeks to allocate equally among investments or asset classes based on contribution of risk, or volatility, rather than a percentage of total assets.

     

    S

    SELECTION BIAS

    An effect that can make an index, peer group, or category average performance better than the actual experience of a hedge fund or mutual fund investor. Selection bias happens when the funds themselves, or another group of individuals, select the constituents of an index, category average, peer group, or database.


    SHARPE RATIO

    A risk-adjusted measure of return which uses standard deviation to represent risk. Specifically, it is the annualized excess return of the manager over the 3 month Treasury (risk free rate of return) divided by the standard deviation of returns. A larger Sharpe ratio implies more return for less risk.


    SHORTING

    The selling of a borrowed security with the expectation of profiting from a decline in price in contrast to the ordinary investment practice, where an investor “goes long” by purchasing a security in the hope the price will rise.


    STANDARD DEVIATION

    A measure of volatility that indicates the “risk” or degree of potential price movements associated with an investment.


    SURVIVORSHIP BIAS

    An effect that can make an index or category average performance better than the actual experience of the hedge fund or mutual fund investor. Survivorship bias happens when hedge funds or mutual fund returns are dropped from the past history of an index or category average when the hedge fund chooses to stop reporting or when the hedge fund or mutual fund liquidates.

     

    SYSTEMATIC

    See Quantitative.

     

    T

    TACTICAL TRADING

    An investment strategy that seeks to profit by adapting to changing trends across asset classes. Also a GSAM Liquid Alternative Investment Peer Group category as defined by GSAM.

     

    TOP-DOWN

    An investment strategy that starts by selecting securities based on their country, sector, or industry.

     

    TOTAL RETURN

    The change in value of an investment that represents both price appreciation / depreciation and yield.

     

    TRADING MORNINGSTAR CATEGORIES

    A set of Morningstar alternative categories. According to Morningstar, Inc., http://corporate.morningstar.com/us/documents/MethodologyDocuments/       MethodologyPapers/ MorningstarCategory_Classifications.pdf

     

    TRADING-INVERSE COMMODITIES MORNINGSTAR CATEGORY

    These funds seek to generate returns equal to an inverse multiple of short-term returns of a commodity index. The compounding of short-term returns results in performance that does not correspond to those of investing in the index with external leverage. For example, a fund attempting to achieve negative 2 times the returns of a given index on a daily basis is unlikely to deliver anything like negative 2 times the index’s returns over periods longer than one day. Many of these funds seek to generate a multiple typically negative 1 to negative 3 times of the daily or weekly return of the reference index. Trading funds are not considered suitable for a long-term investor and are designed to be used by active traders.

     

    TRADING-INVERSE DEBT MORNINGSTAR CATEGORY

    These funds seek to generate returns equal to an inverse fixed multiple of short-term returns of a fixed-income index. The compounding of short-term returns results in performance that does not correspond to those of investing in the index with external leverage. For example, a fund attempting to achieve negative 2 times the returns of a given index on a daily basis is unlikely to deliver anything like negative 2 times the index’s returns over periods longer than one day. Many of these funds seek to generate a multiple typically negative 1 to negative 3 times of the daily or weekly return of the reference index. Trading funds are not considered suitable for a long-term investor and are designed to be used by active traders.

     

    TRADING-INVERSE EQUITY MORNINGSTAR CATEGORY

    These funds seek to generate returns equal to an inverse fixed multiple of short-term returns of an equity index. The compounding of short-term returns results in performance that does not correspond to those of investing in the index with external leverage. For example, a fund attempting to achieve negative 2 times the returns of a given index on a daily basis is unlikely to deliver anything like negative 2 times the index’s returns over periods longer than one day. Many of these funds seek to generate a multiple typically negative 1 to negative 3 times the daily or weekly return of the reference index. Trading funds are not considered suitable for a long-term investor and are designed to be used by active traders.

     

    TRADING-LEVERAGED COMMODITIES MORNINGSTAR CATEGORY

    These funds seek to generate returns equal to a fixed multiple of short-term returns of a commodity index. The compounding of short-term returns results in performance that does not correspond to those of investing in the index with external leverage. For example, a fund attempting to achieve 2 times the returns of a given index on a daily basis is unlikely to deliver anything like 2 times the index’s returns over periods longer than one day. Many of these funds seek to generate a multiple of the daily or weekly return of the reference index. Trading funds are not considered suitable for a long-term investor and are designed to be used by traders.

     

    TRADING-LEVERAGED DEBT MORNINGSTAR CATEGORY

    These funds seek to generate returns equal to a fixed multiple of the short-term returns of a fixed-income index. The compounding of short-term returns results in performance that does not correspond to those of investing in the index with external leverage. For example, a fund attempting to achieve 2 times the returns of a given index on a daily basis is unlikely to deliver anything like 2 times the index’s returns over periods longer than one day. Many of these funds seek to generate a multiple of the daily or weekly return of the reference index. Trading funds are not considered suitable for a long-term investor and are designed to be used by active traders.

     

    TRADING-LEVERAGED EQUITY MORNINGSTAR CATEGORY

    These funds seek to generate returns equal to a fixed multiple of the short-term returns of an equity index. The compounding of short-term returns results in performance that does not correspond to those of investing in the index with external leverage. For example, a fund attempting to achieve 2 times the returns of a given index on a daily basis is unlikely to deliver anything like 2 times the index’s returns over periods longer than one day. Many of these funds seek to generate a multiple of the daily or weekly return of the reference index. Trading funds are not considered suitable for a long-term investor and are designed to be used by active traders.

     

    TRADING-MISCELLANEOUS MORNINGSTAR CATEGORY

    These funds seek to generate returns equal to a fixed multiple (positive or negative) of short-term returns of an index. The reference index for this category is not equity, fixed-income, or commodity linked. The compounding of short-term returns results in performance that does not correspond to those of investing in the index with external leverage. For example, a fund attempting to achieve 2 times the returns of a given index on a daily basis is unlikely to deliver anything like 2 times the index’s returns over periods longer than one day. Many of these funds seek to generate a multiple of the daily or weekly return of the reference index. Trading funds are not considered suitable for a long-term investor and are designed to be used by active traders.

     

    TREND FOLLOWING

    See Managed Futures.

     

    V

    VOLATILITY

    The tendency of a security or index to swing in price; often calculated using standard deviation.

     

    VOLATILITY ARBITRAGE

    An investment strategy that involves buying and selling options which are perceived to be mispriced.


     

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