Glossary of investments: Get to know important technical terms

Alternative investments are suitable for achieving greater portfolio diversification. In general, this includes everything not belonging to the traditional investment categories, such as equities and bonds. Examples of alternative investments are: private equity, real estate, hedge funds or raw materials. Compared to traditional asset classes, alternative investments are often more complex, differently regulated and less liquid. This means they are to be classified as more demanding and bind invested capital longer. Consequently, a longer investment horizon is usually required. In return, this form of investment is less exposed to interest rate developments and the stock markets fluctuations, the so-called lower correlation.

Bonds are investment instruments that function in a similar way to loans. Companies, governments or other institutions need money in order to finance their investments. To this end, they acquire money on the capital market and pay the creditors/investors a fixed or variable rate of interest for a determined period.
The interest rate, also known as a coupon, can be fixed or oriented around a reference interest rate. The amount depends on the financial situation (creditworthiness) of the issuer of the bond, the term to maturity and the general interest rate level. As a rule, bond issuers with a good credit rating pay lower interest than those with a bad credit rating. The longer the term of the bond, generally speaking, the higher the interest rate, since the money is tied up for a longer period of time.
At the end of the term, the creditor is returned the invested amount in full. In exceptional cases, the issuer may also default. In general, the following applies: The higher the credit rating of the issuer, the lower the risk of default. Consequently, bonds are usually less risky than equities and contribute to the diversification of a portfolio. Bonds are traded on the stock market. They can be bought and sold at any time. In each case, before investing in bonds it is important to determine the credit rating of the issuers, the interest situation and the term to maturity.

The abbreviation "BVV2" stands for Ordinance on occupational retirement, survivors' and disability pension plans. The ordinance regulates relevant details such as the minimum interest rate, the conversion rate and investment regulations.
According to these investment regulations, the occupational pension institutions - the pension funds - are responsible for investing the money of their insured persons with an appropriate distribution of risk. They are therefore required to invest in different investment categories, regions and economic sectors in order to spread the risk appropriately. Different legal requirements apply to the individual asset classes with regard to how large their share may be, at most, in relation to the total assets. For example, a maximum of 50 percent of the total assets may be invested in equities, a maximum of 30 percent in real estate, and a maximum of 15 percent in alternative investments.

Cash flow refers to the positive result from the cash flow statement, in which all cash inflows and outflows of a company within a defined period are offset against each other. Ideally, you look at the cash flow over several years in order to compare different periods. The cash flow is also referred to as the cash or payment flow of a company and provides information about its liquidity and earnings. If the cash flow is positive, a company has generated a surplus. It can then use this, for example, to finance investments, pay dividends to shareholders or repay debts. If the cash flow is negative, more money has flowed out of the company than into it, which can indicate a liquidity bottleneck. The cash flow therefore allows conclusions to be drawn about the extent to which a company can finance itself, instead of being dependent on outside capital.

Collective investment schemes, also known as investment funds or mutual funds, are utilized by investors as a means of pooling their assets in order to invest as a group and have these assets jointly managed. Such vehicles afford investors broad diversification with a smaller minimum investment. A single collective investment may be placed in equities, real estate, commodities and other asset classes. In contrast to investing in individual securities, investment funds and other collective investment vehicles afford greater diversification, reducing risk. Investors benefit from economies of scale as well through such vehicles, as investment management costs are shared, lowering costs for the individual investor entities involved. The invested assets are managed for the investors by a fund management company in accordance with a defined investment policy and strategy. Investment funds (or ‘funds’) offer a simple and cost-efficient way to invest in different asset classes.

Duration measures how long it takes for an investor to recover the price of a bond through the bond's recurring fixed interest payments. In general, the following applies: The longer the duration of a bond is, the more its price will fall when interest rates rise - and vice versa. This is because when interest rates rise, the fixed interest rate of a bond is less attractive than that of newly issued, higher-interest bonds. So if interest rates rise by 1 percentage point, for example, a bond with an average maturity of five years would probably lose about 5 per cent of its value, as can be seen from the following example:
Someone has a bond of 100, which pays 2 per cent and has five years to go. So after five years his bond will bring him 110. If interest rates rise by 1 per cent, he could buy a bond of 100 with 3 percent interest. This would bring him 115 after five years. If you only look at the interest, it has a minus of five; in relation to the invested capital of 100, that makes 5 percent.

The abbreviation ESG relates to sustainability criteria that are taken into account as part of the investment process. As stated above, ESG stands for Environmental, Social and Governance. In contrast to traditional portfolios, ESG strategies take the aforementioned criteria into account in order to put together their portfolio in a correspondingly sustainable manner. There is no uniform standard for how ESG criteria are defined or weighted, but it is roughly as follows:

• Environment: Environmental factors are about the extent to which an organization pays attention to the protection of natural resources. These include energy consumption, energy use and measures to combat climate change throughout the supply chain.
• Social: Social factors include how an organization engages with society and how it treats people, for example in terms of health and safety at work.
• Governance: This is about responsible corporate governance based on transparency, proven industry standards or control processes.

Excess return describes the additional profit, which an investment has achieved in comparison to the return on a risk-free investment in the same time period.
In addition, the excess return shows whether undertaking the high-risk investment was worthwhile. As a rule, an excess return is accompanied by higher risk.
In order to calculate the excess return, the risk-free market interest rate is subtracted from the return achieved by an investment. For example, the excess return is 2 percent, if the risk-free achievable return is 4 percent and the high-risk investment has generated a return of 6 percent.

A fund can be seen as a kind of collection pot. This is because many individual investors pay into the fund and thus become part-owners of the fund's assets on a pro rata basis. A professional fund management company invests this money according to an investment strategy in a variety of individual securities, such as shares, bonds or real estate, for example, in order to spread the risk broadly. For example, there are funds that invest in selected regions (e.g. Asia), specific sectors (e.g. food) or asset classes (e.g. equities). The fund manager constantly monitors the price development of the fund and makes adjustments if necessary. What's more, a distinction is made between open-ended and closed-end funds. With an open-end fund, investors can enter and exit at any time. This is not the case with a closed-end fund.
Income generated from price gains, dividends, interest or similar is distributed to the investors. In the case of a so-called accumulating fund, this is reinvested, which in turn increases the value of the fund units.

Interest is the price you pay when you borrow money. It is often referred to as the "cost of money". If you borrow money from a bank, for example, you must pay interest. If you issue a loan to another person, you receive interest.
The amount of interest is determined, among other things, by the interest rate, the term, the debtor's ability to pay, the reason for the loan and the amount of money lent/borrowed. The interest rate is expressed as a percentage. It indicates the amount of interest to be paid. The amount of interest is determined within the scope of a contract and in consideration of the overall interest environment. The higher the interest rate, the greater the amount a person must pay back.
High interest makes loans more expensive, but also makes placing money in savings accounts more attractive. This situation is reversed when interest is low. In this situation, credit is cheap, but money in savings accounts yields lower returns.

A joint venture is an enterprise formed by two or more companies by contributing their resources as partners for the specific purpose of the business venture. A joint venture is a legally independent business entity, and thus not necessarily bound to managerial direction by its founding partners. A joint venture company thus acts independently, managed jointly by its founding partners, who bear the associated financial risk together. Joint ventures are formed in order to capture synergies. The companies backing a joint venture contribute according to their respective strengths and competencies: capital, know-how, production facilities and other resources. Joint ventures are typically formed by companies from different countries interested in entering markets and/or joint product development.

The key interest rate is the rate at which banks can borrow money from a central bank within their currency area. This rate represents the cost of lending money borne by commercial banks. In Switzerland, the key interest rate is set by the Swiss National Bank (SNB), whose primary mission is to ensure price stability. The SNB utilizes the key interest rate to this end, increasing the rate at times to make borrowing more expensive for banks. Banks pass these costs on to borrowers, which means it becomes more expensive for private individuals and companies to borrow. This leads to declining demand for credit, curbing consumer and capital expenditure. Conversely, the SNB may lower interest rates, which has the opposite effect. Borrowing then becomes generally less costly, which tends to fuel consumer and capital expenditure. The key interest rate is thus an important instrument of monetary policy, employed to stabilize prices, i.e. keep inflation under control.

The money market—one of the three monetary financial markets—is the market for trading short-term debt securities. Major market participants utilize the money market as a source of short-term liquidity and to lend out their excess cash holdings at interest. These market participants include the European Central Bank (ECB), the Swiss National Bank (SNB) and other central banks, private and commercial banks, insurance companies and institutional investors. Money market instruments are traded in various forms maturing in twelve months or less—maturities range from one day to one month, three months and beyond. The interest payable on borrowed cash assets is called the money market interest rate, which is determined as a function of supply and demand. Investors frequently utilize money market securities as a place to park cash, investing in exchange-traded money market notes and paper via investment funds. The money market is, therefore, an efficient source of short-term liquidity and a means for lending out excess cash holdings at interest.

Most people looking to buy a home of their own are only able to pay a portion of the cost upfront, financing the rest with a loan. This is typically a mortgage loan, secured by a lien on the property. The mortgage lender—usually a bank or insurance company—retains an ownership claim on the property as security in the event the borrower becomes unable to make the mortgage payments. As a result, the loan is secured by the property itself.
Borrowers are typically required to put up 20 percent of the value of the property they are buying from their own funds. Of this amount, at least 10 percent has to be covered by assets that are not pledged “second pillar” retirement plan assets. Roughly 67 percent of the property value can be financed via a first mortgage. This first mortgage does not have to be amortized, i.e. regularly paid down. Another 13 percent can be financed via a second mortgage. This second mortgage has to be repaid within a maximum of 15 years, or by the date of retirement if earlier. Your lender assesses your creditworthiness before granting a mortgage loan. A mortgage is deemed affordable as long as your total housing costs do not exceed one-third of your income. These costs are calculated as a long-term average, applying an imputed interest rate rather than an actual current rate. This method ensures that you will still be able to afford the financing in the event of rising interest rates.

Net asset value (NAV) is the value of total net assets of a fund divided by the total number of fund units or shares, thus representing the unit or share price of a fund. NAV is calculated as total fund assets net of (less) total fund liabilities. Put somewhat differently, a fund can be thought of as a basket containing various different assets (typically securities). These securities are the fund’s assets, and the total value of everything in the basket divided by the number of fund shares/units held by its investors is the fund’s gross asset value. Funds may hold debts as well as assets, i.e. they may “owe money”. A fund may for example purchase securities on margin, i.e. on credit—from borrowed funds. Subtracting the debts of a fund, i.e. its liabilities, from the value of its portfolio or assets under management in gross (total before netting out liabilities) yields the value of the fund’s assets on a net basis. Net asset value thus accurately represents the value of a fund share at a given point in time. Historical net asset value data is relevant for investors as documentation of a fund’s past performance, potentially in reference to an index as benchmark. Benchmarking versus an index allows comparison against the performance of other funds pursuing the same or a similar investment strategy over a specific period of time. Performance is measured and expressed on the basis of fund net asset value. The redemption price for fund units/shares is the net asset value of the fund’s units/shares less any applicable charges and fees due upon redemption (sale). Net asset value generally represents the per-share market value of a fund, but for closed-end/exchange-traded funds the market value is not necessarily identical to net asset value.

Performance measures the success or development of an individual investment, such as a fund or an entire portfolio. Performance determines how well or poorly an investment has developed in a specific period.
Performance is often linked with return. In this context, the performance measures the profit or loss of an investment in relation to the money invested. This value is given as a percentage.
In addition, it can be compared with a reference value known as a benchmark. This can be used to estimate how well an investment has performed compared to another investment or the overall market.
As a rule, it is useful to observe the performance over a longer period of time. Performance is influenced by many factors: for example, the general market and interest rate trends, company performance or the individual investment strategy. In addition, short-term fluctuations may occur. Consequently, a long-term perspective helps to better assess the overall development.

Pension funds invest the funds contributed by the insured from the 2nd pillar across various different asset classes to ensure appropriate risk diversification. The contributed pension assets are invested in part in diversified funds consisting of several different asset classes, also known as “asset allocation funds”. In addition to fixed-income bonds and equities, the portfolio diversification spectrum may include other asset classes such as commodities, real estate and mortgage-backed securities. The asset allocation funds into which pension funds invest participants’ contributed assets differ primarily by the percentage of exposure to equity as an asset class. Within defined investment policy limits, fund managers can flexibly adapt portfolio allocations in view of current market conditions, in order to meet a long-term return target on the pension assets. Asset allocation funds offer the advantage of being compliant with the BVV2 investment regulations, ensuring that the pension fund fulfills its obligation to diversify its investment holdings.

Investing in real estate can be done directly or indirectly. With direct investment, you own the property and can live in it yourself or rent it out. The investor may thus enjoy returns through regular rental income and/or appreciation in market value. This requires property management activities however, including renting and maintenance. Administration and renovation costs thus have to be included when calculating returns. Investors should also keep in mind the factor that a mortgage loan is usually needed to buy a property. For owner-occupied properties, income taxes are also due on the imputed rental value. In the case of indirect investment, distinction is made between listed and non-listed securities. Examples of non-listed indirect investment vehicles include real estate funds and non-exchange-traded shares in real estate companies. Listed indirect investment vehicles include real estate investment trusts and exchange-traded real estate funds. By utilizing these vehicles to invest in real estate, investors can avoid the disadvantages typically associated with such things, such as illiquidity. Such indirect investment vehicles make it possible to gain exposure to the asset class with smaller amounts. The performance of real estate investments is less correlated with the stock market and interest rates than other asset classes are, they thus increase diversification, reducing risk. Investing in real assets like real estate can provide protection against inflation.

Risk capacity explains how easily a person can absorb fluctuations in value and losses on their investments without entering into financial difficulties. A person's risk capacity is dependent on many individual factors, such as their income, assets, debts, financial obligations or investment horizon.
For example, debt-free, childless, double-income couples, who live in their own home and have paid off their mortgage, generally have a higher risk capacity than low-income couples of the same age with children in compulsory education, a sizable mortgage and few assets.
Risk capacity is closely linked with risk tolerance. Together they form an investor's risk profile. Risk tolerance expresses how well a person can handle fluctuations in value. In other words, whether a person is at all prepared to accept losses and to what extent. This is dependent on the subjective estimation and evaluation of risk. A person's individual investment strategy can be determined on this basis.

Securities is an umbrella term for various financial instruments. These include, for example, equities, bonds, warrants or fund units.
A security is a document evidencing proof of ownership or a debenture. Equities confer a stake in the ownership of a company. Conversely, bonds represent an obligation. One party borrows money from another at fixed, agreed conditions and must pay this money back within a certain time.
Securities used to be printed on paper, which simplified the transfer of the security from one person to another. However, this also made it easier to steal or falsify securities. Today, securities are mostly available in electronic form.
Transferability and tradability are two integral characteristics of securities. They enable trade on the stock markets. Here, securities can be bought and sold at current market prices.

The target return is the minimum annual return on investment that a pension plan (pension fund) must achieve, in order to fulfill all its obligations and maintain a constant cover ratio.
The higher the agreed interest rate for the pension fund, the higher the target return must be. If the return on investment exceeds the target return, the cover ratio increases. If it is lower than the target return, the cover ratio decreases.
The target return is lower than the actual targeted return on investment. The reason for this: Pension funds want to grow their assets. This gives them something to fall back on in years with poor investment performance without suffering a coverage deficiency.

The Total Expense Ratio (TER) is ratio of a fund's total costs. The TER comprises all administration and distribution fees that the fund is obliged to pay in a given financial year. This includes custody fees, marketing costs and other expenses.
The TER does not encompass transaction costs. These include, for example, brokerage and stock market fees as well as any tax payments. These costs are incurred when buying and selling fund units and are not deducted from the fund assets.
The TER is expressed as a percentage. It signifies the ratio between the costs of the fund and the Net Asset Value (NAV). The lower the TER, the lower the costs that the fund is burdened with. This allows the costs of various funds to be compared with one another. This is important, as high costs diminish the overall returns of a fund.

Volatility measures the strength of the fluctuation in the price of an investment around its average value within a certain time period. In other words: It measures the fluctuation in price, and therefore value, of an investment. Significant fluctuations in price equate to high volatility. If price fluctuations are small, this is known as low volatility.
High volatility harbors both opportunities and risks. On the one hand, investors can profit from strong price gains. On the other hand, they can also suffer significant losses.
Various factors influence volatility: e.g. economic or political events, company or subsidiary news and even psychological aspects. High volatility can trigger strong emotions, such as fear or euphoria, and thus increase price fluctuations.

Withholding tax is a form of income tax. This entails tax being directly deducted from income and transferred to the cantonal tax authorities in Switzerland. Two groups of foreign employees are affected by this:

• Natural persons with a tax residence or domicile in the canton: for example, foreign employees
• Natural and legal persons without a tax residence or domicile in Switzerland: for example weekly/cross-border commuters, athletes/artists, administrative boards

Each month, the employer deducts the applicable tax contribution from the salary of these persons and transfers it to the tax authorities. In Switzerland, this amount comprises income tax owed to the Confederation, the cantons and the communes. The same principle applies to income from insurance, pension funds or investments. In return, those subject to withholding tax in Switzerland need not fill out a tax declaration. The amount of this withholding tax varies from canton to canton.

The return earned when a security matures is known as the Yield to Maturity (YTM). It is a ratio for fixed-interest securities such as bonds and is expressed as a percentage, and it shows the average expected annual return, provided that the security is not sold before maturity.
It also helps when deciding whether it is worth selling the security ahead of time or holding it until maturity. In addition, this allows various bonds and their expected returns, for example, to be compared.
From the perspective of the buyer, the YTM allows you to estimate how much can still be earned with a bond until it matures.