Glossary
The banking industry uses a number of technical terms, and it is often – wrongly – assumed that everyone knows what these mean. This section contains some key terms that appear on our website and in our documents, with definitions of their meanings.
Asset management
“Don’t put all your eggs in one basket.”
Asset allocation is the most important performance driver in a diversified portfolio. It combines the art and science of allocating investments across different kinds of assets to optimise risk and reward in a portfolio.
An asset class is a category of financial instruments which tends to react similarly in different market conditions and which adheres to the same rules and regulations. The principal asset classes are: cash; equities (including listed, unlisted, domestic, and foreign), which are securities linked to the capital of the issuing company; bonds, which are debt securities from the issuer (such as government and corporate bonds); commodities (e.g. precious and heavy metals, agricultural commodities and energy); derivatives (including swaps, options and futures); and real estate and collectors’ items, for example, artworks, precious coins, wine and stamps.
Every asset class offers its own risk and return outlooks. Historically, equities tend to offer better capital value potential than bonds, but at a higher relative level of risk. Cash has a weaker return expectation, but it ensures liquidity and protects the initial investment. In modern investment theory, a portfolio diversified across uncorrelated asset classes offers higher return outlooks for a level of risk that is lower than that of a less diversified portfolio. Asset allocation is the process that enables the weighting of each asset class within the portfolio to be optimised according to an investor’s expectations and risk tolerance.
Asset management involves investing across different types of financial asset, such as equities, bonds, monetary products, commodities and derivatives. This capital can be own-account or come from a third party (either institutional or individual), which is known as third-party asset management or fiduciary management. Asset managers and asset management companies act in line with regulatory and contractual constraints. Their aim is to get the best possible return given an investor’s level of risk tolerance.
Collective management accounts for the lion’s share of the asset management universe. It consists of attracting funds from a range of investors, all of which are then managed within a mutual fund, which follows an overarching asset management policy.
Two major approaches coexist within collective management. In the case of active management, the asset manager picks the stocks that they are going to buy or sell after having carried out a range of analyses on them. Their aim is to outperform the benchmark.
In contrast to this, passive asset management (also known as index-linked management) involves replicating a benchmark’s performance as closely as possible. Proponents of this approach believe that markets are efficient, meaning that they incorporate all relevant information and that an active approach is unnecessary. Passive management costs are generally lower than active management costs.
A reference parameter – or “benchmark” – is used to compare the performance of an investment strategy or of a portfolio of assets. It measures the market’s performance and volatility and reflects whether the portfolio’s management team has outperformed or not. For example, if a portfolio contains a varied selection of Swiss equities, the benchmark might be the SMI, which is Switzerland’s broad index of the twenty most important equities in the Swiss Performance Index.
A fund of funds enables clients to invest in a variety of funds that offer different investment strategies, rather than investing directly in just one strategy. These are often used to reduce the volatility of a single strategy.
A master/feeder structure is used when a strategy is offered across various regulatory environments. Both funds will accept subscriptions and redemptions, but the feeder will invest all the proceeds in the master. Portfolio management is decided at master-fund level. Feeder funds are separate legal entities and may therefore show a difference in minimum investment amounts, investor types, fees and net asset value (NAV).
The goal of any investment strategy is to generate positive returns or to limit the downside in negative market conditions. Performance can thus be indicated in absolute or relative terms when compared to a benchmark. Performance is measured as gross or net, with the latter being the return after fees and expenses have been deducted. Some investment managers take a performance fee on the assets they manage, calculated against the portfolio’s outperformance when compared to its benchmark.
Generally speaking, one of central banks’ main purposes is to keep inflation under control, but also to support economic activity. To achieve this, they put in place a monetary policy that takes account of economic developments. The main tool a central bank has to steer monetary policy is its key interest rate – the rate for loans to commercial banks, which then charge it, along with their own margins, for the loans that they in turn make to their clients, i.e. households and businesses.
When a central bank increases its key rate, commercial banks’ interest rates rise. The cost of borrowing becomes more expensive for households and businesses, which causes them to borrow less, and spend and invest less, too. Consequently, economic activity slows and this tends to contain inflation. If a central bank reduces its key rate, the inverse is true.
After more than a decade of highly accommodative monetary policies comprising low and indeed negative interest rates, as well as longer-term refinancing operations and asset purchases, the post-Covid recovery, marked by a rapid increase in inflation all around the world, led to the majority of central banks increasing their key rates.
Legal & compliance
The Alternative Investment Fund Managers Directive (AIFMD; Directive 2011/61/EU) aims to create a comprehensive and effective regulatory and supervisory framework for managers of so-called alternative investment funds (AIF) (i.e., generally speaking, any European or foreign fund which is not a UCITS) at European level. The proposed Directive aims to provide robust and harmonised regulatory standards for all such managers (called “AIFMs”) within the scope of the Directive and to enhance the transparency of the activities of AIFMs and the AIFs they manage for investors and public authorities.
Due to the increasing sophistication of financial products, cross-border transactions and the financial crises of recent years, the banking and financial world is subject to ever-growing regulatory complexity.
Compliance is the duty of a bank to comply with the relevant regulations and to mitigate the risk of breaching any rules. Consequently, each staff member is responsible for ensuring conformity with all internal policies and guidelines, in compliance with external laws and regulations.
A compliance department ensures that a company applies and adheres to all relevant rules, regulations and laws. Compliance can be seen as an in-house team in charge of verifying a company’s compliance with the applicable regulations. The tasks of a compliance department are performed independently as part of a bank’s in-house oversight system, in particular in the context of transaction monitoring, trading monitoring, preventing money laundering, and ensuring that employees are up to date with new rules and regulations. In Switzerland, for example, the Loi sur le blanchiment d’argent (LBA) or Anti-Money Laundering Act (AMLA) stipulates that all transactions comply with a number of provisions, and all employees must regularly participate in training courses on this subject. Any anomalies must be reported immediately to a compliance officer who will evaluate the issue and take the appropriate measures.
FCP stands for the French expression fonds commun de placement, meaning an open-ended collective investment fund. Like a unit trust in the UK, an FCP is set up in the form of a contract between the fund manager and the investor(s), in a similar way to a partnership, and is not a separate legal entity in its own right. Instead, the legal entity is the management company setting up the fund. Investors hold units in an FCP. (Adapted from the ALFI – Association of the Luxembourg Fund Industry website.)
“FINMA is Switzerland’s independent financial-markets regulator. Its mandate is to supervise banks, insurance companies, exchanges, securities dealers, collective investment schemes, and their asset managers and fund management companies. It also regulates distributors and insurance intermediaries. It is charged with protecting creditors, investors and policyholders. FINMA is responsible for ensuring that Switzerland’s financial markets function effectively.” (From the FINMA website.)
LPCC stands for Loi fédérale sur les placements collectifs de capitaux, or Collective Investment Schemes Act (CISA). This piece of Swiss legislation aims to protect investors and to ensure transparency and the proper functioning of the market for collective investment schemes.
The Act governs the following, irrespective of their legal status:
- Swiss collective investment schemes and persons who are responsible for the management and distribution of such schemes, and the safekeeping of assets held in them;
- the distribution of foreign or Swiss collective investment schemes in or from Switzerland;
- people who manage Swiss or foreign collective investment schemes;
- people who distribute foreign collective investment schemes which are exclusively reserved for qualified investors;
- people who represent foreign collective investment schemes in Switzerland.
(From the website of the Swiss Federal Council.)
MiFID stands for the Markets in Financial Instruments Directive (Directive 2004/39/EC). It has been in force since November 2007, governing the provision of investment services in financial instruments by investment firms, and the operation of traditional stock exchanges and alternative trading venues.
In October 2011, the European Commission put forward proposals to revise the Markets in Financial Instruments Directive (MiFID 2). The aim of this was to make financial markets more efficient, resilient and transparent, and to strengthen the protection of investors. (From the European Commission website.)
This word is borrowed from Swedish and means a person who has been appointed by a government agency or company to fairly investigate and deal with problems and complaints. For example, the Swiss Banking Ombudsman deals with specific complaints which are raised against banks based in Switzerland. The Banking Ombudsman is independent, neutral and handles inquiries in the strictest confidence. (Ombudsman website)
SICAV stands for Société d’Investissement à Capital Variable, or investment company with variable capital (also known as an “open-ended investment company”) and which issues shares. With SICAVs, the fund itself is a stock corporation and thus a legal entity. The company’s capital depends on the amounts paid in by investors. Shares in a SICAV are bought and sold on the basis of the value of the fund’s assets, or net asset value (NAV). In accordance with applicable law and regulations, a SICAV can either appoint a separate management company or can be self-managed. (Adapted from the ALFI – Association of the Luxembourg Fund Industry website.)
UCITS stands for Undertakings for the Collective Investment in Transferable Securities. These are investment funds regulated at European Union level. They account for around 75% of all collective investments by small investors in Europe. The legislative instrument covering these funds is Directive 2014/91/EU. (From the European Commission website.)
As these funds are regulated at European level, they can be marketed across the EU without having to be concerned with which country a fund is domiciled in, thanks to a straightforward notification procedure. This approach saves costs for fund providers, as they no longer have to create specific funds for each market.
Due to the intense regulatory process to have a fund approved as UCITS compliant by a regulator, the UCITS label serves as a stamp of quality and reliability for investors.
FATCA stands for Foreign Account Tax Compliance Act, a 2010 United States federal tax law. Its purpose is to combat tax evasion by US taxpayers and allows the US tax authorities (the Internal Revenue Service or IRS) to require all financial institutions in the world, such as banks, investment funds, life insurance companies, custodians, asset managers, and pension funds, to submit information on the accounts held by US citizens.
Like many other countries, Switzerland has entered into a bilateral agreement with the US to facilitate the implementation of FATCA, which came into force in June 2014. Under the FATCA agreement, Swiss financial institutions must directly provide the IRS with the information it requires with the prior consent of the clients concerned. Should a client not consent to this information being shared, the financial institution will disclose it after aggregating and anonymising it. Since the implementation of the Protocol of amendment to double-taxation agreement (DTA) between Switzerland and United States of America, on the basis of such aggregate data the IRS can then ask Switzerland’s Federal tax administration for access to specific information relating to clients and accounts as part of a group request for administrative assistance.
Risk management
Performance attribution is a method that uses quantitative tools to evaluate how investment choices made by a portfolio manager affect the performance of the portfolio against a benchmark. If there is a discrepancy between the portfolio and the benchmark, these tools help to determine the cause(s). The two main factors that are analysed are stock selection and asset allocation.
Volatility measures risk, reflecting the level of variation of the price of a security. Volatility is calculated on the standard deviation of the return of an asset over a certain period of time. For example, if an instrument has a volatility of 20% then it has the potential of increasing or decreasing by that amount over the given time. The higher the volatility, the higher the risk. Beta measures the volatility of a stock relative to the market.
Financial metrics
CFROI® (cash flow return on investment) is an indicator of a firm’s ability to create value. Technically, CFROI® is the average level of internal profitability that is equal to a firm’s economic assets, taken as a gross total (i.e. before depreciation costs) and adjusted for inflation, and the series of gross surpluses after tax, calculated over the lifetime of fixed assets. The last of these is estimated by dividing the gross value of capital assets by the year’s depreciation costs. Compared to the average weighted capital cost, CFROI® enables the calculation of the extent to which a firm’s cash flows are superior to its cost of capital.
The CFROI® is also a means of assessment if one assumes that a company’s cash flows are a better indicator than its earnings (the price/earnings ratio), which are often subject to accounting distortions. It is used to compare the economic profitability of a firm to that of its peers, and its variation from one year to another gives an indication of its development. It is also interesting to establish a relationship between the CFROI® and a firm’s share value; for example, if an investor believes that the heightened CFROI® of a firm is badly reflected by its share price, they will exploit this assessment anomaly by betting on a rising share price.
Formerly known as Morgan Stanley Capital International, MSCI became independent in 2007. It is a financial services company that markets research and analysis tools to institutional investors. It is the global leader in market indices that it publishes under the MSCI brand. The best known of these indices – the MSCI World – is an index that is weighted by stock market capitalisations listed in some twenty economically developed countries. It comprises some 1,500 names [MOU1] which represent the major sectors of the global economy. Among MSCI’s other indices, the MSCI Europe reflects the performance of the fifteen main markets of the European Union.
Launched in 1988, the MSCI Emerging Markets Index also commands a great deal of interest. This index is made up of 1,373 companies [MOU2] listed across 24 emerging countries that have been chosen according to their levels of economic development, their size, their liquidity conditions, and market accessibility. In particular, the index includes China, Greece, Mexico, Peru, Poland, Qatar, Turkey, and South Africa.
The MSCI Frontier Markets Index is dedicated to so-called “frontier” markets, i.e. those markets which do not offer the same levels of liquidity, foreign investor access or economic development as emerging markets. This designation includes countries such as Kuwait, Morocco, Nigeria and Vietnam. Frontier markets offer a greater decorrelation to developed markets.
(Sources: MSCI World Index and MSCI Emerging Markets Index)