Select an investment term from the list below to jump to the appropriate section of the glossary.

Investment terms explained

asset classes

Investments with similar characters can be grouped together in asset classes. The main asset classes are cash, fixed interest, shares, and property. Often, asset classes are categorised as Australian or International (which include assets from all major global markets).

Asset classes can be divided into two types: growth assets (shares and property) which provide investors with the potential for capital growth and some income, and defensive assets (cash and fixed interest) which provide a high level of security together with regular income.

Historically, growth assets provide higher long-term returns than defensive assets but can be more volatile, that is, their value can go up and down. This means there is the potential for losses and negative returns in the short term.

Some investments have characteristics that fall outside the traditional asset classes. These investments include infrastructure, together with ‘alternative’ investments such as hedge funds and private equity.

STRATEGIC ASSET ALLOCATION

Strategic asset allocation is the process of setting target weightings of different asset classes based on an investor’s objectives, timeframe, and risk tolerance.

A higher allocation to growth assets (shares and property) will generally produce higher returns over the long term, whereas a portfolio with a higher allocation to defensive assets (cash and fixed interest) is likely to generate lower returns, but provide a greater level of stability.

As an example, AAN Asset Management’s Core Model holds 65% growth assets and 35% defensive assets, making it suitable for clients prepared to accept some investment risk, but seeking more stable returns than those potentially available from a higher exposure to growth assets.

Our investment models do not use labels like ‘Balanced’ or ‘Conservative’ – we believe these terms can be misleading, with little consistency in their use by investment managers. As an example, some managers offering a Balanced fund may hold up to 90% in growth assets, whereas other Balanced funds adopt a mix of 50% growth assets and 50% defensive assets.

TACTICAL ASSET ALLOCATION

Tactical asset allocation is a strategy seeking to profit from short-term movements in asset classes. As an example, a manager might believe the share market is undervalued, and transfers capital from another asset class to shares.

To be successful, the manager needs an insight into the future direction of markets.

If the manager’s insights prove incorrect, then they may have taken money from an asset class which then outperforms and invested in an asset class which underperforms.

Because of the unpredictability of financial markets, we do not believe it is possible to accurately forecast market trends in the short term.

As a result, we do not apply tactical asset allocation in the construction of our models.

STYLES OF INVESTMENT MANAGEMENT

Investment managers can generally be classified as either passive managers, or active managers. Passive managers aim to achieve the same returns as a nominated benchmark or index by investing in the same stocks, in the same weightings as the relevant index. For example, a passive ASX200 fund would invest in the largest 200 ASX-listed companies, expecting to generate the same return as the index before fees.

Active managers aim to generate higher returns than a nominated benchmark or index by selecting investments they believe will perform better than the average.

This could be investing in a sector they believe is likely to grow strongly (like technology) or focusing on companies with a track record of growing earnings.

Despite the number of active investment managers in the market, only a limited number of recognised brands have consistently outperformed their peers.

VALUE VS GROWTH

Active managers are often described as value managers, or growth managers.

Value managers seek to invest in stocks they believe are trading at a discount to their real value. Value stocks are often large, well-established companies that are out of favour with the market. Value managers believe that, over time, the underlying value of the business will be recognised, and the share price will rise to reflect that value.

Growth managers look for stocks they believe will continue to grow their earnings and outperform the market into the future. This could be due to astute management, a unique product, or poorly performing competition.

Value and growth styles tend to perform differently at various stages of the economic cycle.

SEQUENCING RISK

Sequencing risk is the danger of significant falls in an investment portfolio at a time when it is difficult to recoup the losses.

As an example, a large fall in the share market may impact investors differently. A 65-year-old facing retirement may need to reconsider their retirement plans based on a reduced asset base. A 30-year-old is less affected, as they have decades before retirement, during which time markets will recover.

Sequencing risk was most evident in the Global Financial Crisis, when recent retirees were hard-hit by falling markets, but were still forced to draw down on their reduced capital base to fund their income.

We believe clearly identifying the income and growth components of a portfolio can help reduce sequencing risk. This allows retirees to draw income from their portfolio, while leaving growth assets to recover. This allows retirees to weather significant market volatility without the need to draw on their capital base.

SEPARATELY MANAGED ACCOUNTS (SMA’S)

Separately Managed Accounts provide investors with access to a professionally managed, diversified portfolio of investments.

Unlike a traditional managed fund, where your money is pooled with that of other investors and held by a trustee, an SMA gives you direct ownership of your investments with far greater transparency of your actual investment holdings.

We believe SMAs offer our clients a number of advantages when compared to traditional managed funds:

TAXATION

As the investments are in your name, or the name of your entity (for example, you may invest as the trustee of your Self-Managed Super Fund), the taxation impacts are based only on your tax position, not shared with other investors.

Unlike managed funds, which may have unrealised capital gains or losses already existing in the fund, when you invest in an SMA you start with a  clean slate. 

This means any capital gains tax liability will only be incurred when your investments are sold.

You are also entitled to receive income from the underlying assets, including 100% of the benefits of any franking credits distributed.

REPORTING

SMAs streamline the paperwork and administration required compared to holding a number of investments. Events such as corporate actions are managed on behalf of the investor, with an accurate, consolidated tax report provided to assist with the completion of your tax return.

TRANSACTION SPEED

SMAs provide the ability to invest, or transfer between investments quickly and efficiently.

Investment in an SMA is generally confirmed at close of business, with the transaction visible in your account. In contrast, it can take up to 10 days to confirm an investment in a managed fund.

Transactions between SMAs are also more efficient, with the sale of an SMA to an alternative SMA or ETF finalised within days.

There can be lengthy delays in withdrawing from traditional managed funds (up to 10 or 15 days), during which your funds are not working for you.

EXCHANGE TRADED FUNDS (ETF’S)

As the name suggests, Exchange Traded Funds are managed funds that are traded on a stock exchange. A wide variety of ETFs are available, providing exposure to all asset classes including fixed interest and international shares. Most ETFs are structured to mirror the return of a particular benchmark or index, for example, an ETF might be designed to provide the same return as the ASX200, a measure of the largest 200 ASX-listed companies.

We use ETFs to give our clients cost-effective exposure to certain markets.

While ETFs lack the transparency of SMAs, they provide similar ownership advantages – the investment is held in your name or the name of your entity, and as they are traded on the ASX, transactions are fast and efficient.

Some ETFs don’t actually hold investments – instead, they use ‘synthetic’ strategies, such as using derivatives and complex financial instruments to replicate the performance of an index. We believe that adds risk, and our investment models only include ETFs with actual physical holdings.

ILLIQUID ASSETS

Illiquid assets are those which cannot be readily converted to cash.

Often, large institutional investors will hold illiquid investments such as infrastructure (toll roads, airports), direct property (industrial premises and CBD offices) and a range of alternative investments. These can be appropriate for large investors with a very long timeframe (often measured in decades) who are unlikely to need to sell the asset.

Infrastructure and property investments often involve significant borrowings, which increases risk.

A forced sale in troubled economic times (such as property crashes in 1989 and 2008) can see investors suffer large losses. In extreme cases, investors stand to lose all their capital. Because of that inability to redeem these investments in declining markets, we do not include them in our investment models.

SUSTAINABLE INVESTING

Sustainable investing is the process of assessing a broader range of metrics than simply profitability when investing, with a view to identifying businesses likely to thrive into the future.

Typically, this will include how a company manages its environmental impacts, whether the company makes a contribution to society by treating all stakeholders – staff, customers and suppliers – fairly, and whether the company adheres to high standards of governance and corporate behaviour.

Sustainable investing had its origins in ethical investing, the practice of basing investment decisions on whether a company’s activities were aligned to an investor’s moral and ethical framework.

As an example, some investors might prefer to avoid companies involved with the manufacture of weapons or tobacco, and actively pursue companies involved in renewable energy or education. Choosing ethical investments can be highly subjective, and a fixed approach is unlikely to satisfy all investors.

Sustainable investing, sometimes called ESG investing (environmental, social and governance) is a more comprehensive process. While a sustainable investment model might avoid companies involved with arms manufacture or uranium for example, it might also filter those with a poor record of governance and corporate accountability. 

For more information about sustainable investing, please refer to the AAN Asset Management Sustainable Investment Policy.

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