Dividend Yield At any given time, the dividend yield of a company (or fund that invests in dividend-paying companies) is the net dividend payment over the past year divided by the current share price. So, if today’s share price is £1.00, and in the last year the company has paid an interim dividend of 1p and a final dividend of 2p, then the dividend yield is 3.00%. The yield figure changes all the time with price movements, and less frequently with changes in the payment rate.

 

Double Top (see Chart Analysis).

 

Downside The potential for losses to be made on an asset.  Downside risk is always a matter of opinion, and varies a great deal from one commentator to the next. ‘The downside is limited’ you may hear.  We say, caveat emptor.

Downtrend (see chart analysis)

Dow Theory (see chart analysis)

Earnings per share A company’s earnings per share (EPS) is the profit for a given period divided by the number of shares in issue. For example, if the company has a million shares in issue and has made a profit of £120,000, the EPS is 12p.

Earnings Yield A company’s earnings yield is the earnings per share divided by the share price. If the share price is £1.00, and the earnings per share is 12p, then the earnings yield is 12%. Earnings yield is a measure of value, and as a general rule the higher the earnings yield of a company, the better value the company’s shares are.  Earnings yield is a better measure of value than dividend yield.

Endowment mortgage A mortgage where the borrower pays interest to the lender and uses an endowment policy to repay the loan at the end of the period. Endowment policies can be either with-profits, where the investment returns are added in the form of bonuses, or unit-linked, where returns are directly linked to assets held in the investor’s chosen funds.  The concept of endowment mortgages is fundamentally flawed, in our view, because it relies on future price rises which can’t be predicted, to repay an exact sum at an exact time in the future which can be predicted.  The risk that the required return will not be achieved makes the contract one to avoid for most people. The relatively high charges on endowment contracts, plus their complexity, together with unwise investment policies followed by the insurance companies in the 1990s, have given rise to millions of complaints from investors, on the basis that the risks were not explained to them. Wise Investment, however, stopped recommending endowment mortgages in the early 90’s.

Equity The word equity means equality, but in an investment context equities are shares.

 

Equity Income Fund An equity income fund is one which invests in shares.  The fund will normally be a unit trust or OEIC.  The investment will normally be in the UK.  An equity income fund will normally have a target dividend yield which is above that of the stock market as a whole.  Each fund has its stated target yield, but 10-20% above the market is not uncommon.  Today the dividend yield on the UK market is around 3.10%

However, yields will also vary because some funds take their charges from the income (which may reduce the yield below the market rate) some take their charges from capital, and some a combination.

 

Equity Risk Premium (see Capital Asset Pricing Model).

 

Ex-dividend (xd) Literal meaning ‘without the dividend’.  When a company receives its accounts, the directors will declare a dividend.  Let’s say the dividend is declared on the 25^th of March, with an ex-dividend date of June 1^st, and a dividend payment date of July 1^st.  If a shareholder sells the share before June 1^st, the share is still ‘cum dividend’, i.e. it still has the dividend attached so the new owner has the right to it.  If the shareholder waits till June 1^st, or after, and then sells the share, (s)he keeps the right to the dividend. For this reason, the price of a share often falls on the day it goes xd.

 

Final bonus Also known as terminal bonus.  See with-profits.

 

Financial Services Authority (FSA). The regulatory body which oversees all financial institutions in the UK, including Wise Investment.

 

Final Dividend (see dividends)

 

Final Salary (see Pensions)

 

Fixed-Interest A loan where the borrower agrees to pay a rate of interest which is fixed throughout the term of the loan, rather than fluctuating with interest rates. Fixed-interest debt is attractive to investors, because they know in advance what they will be paid, and when.  Issuers of fixed-interest debt, are normally governments, including sometimes local government, and companies.

Fixed interest investments work the opposite way to a deposit account. On deposit, your capital value will stay the same, but the interest rate will change. With fixed interest, the interest rate stays the same, but the capital value can rise and fall, under the pressure of market forces – e.g. fixed interest prices will tend to rise if interest rates fall, or are expected to fall, and vice versa.

The fixed-interest market is highly sophisticated, with less risky issuers paying a lower yield, all the way through to ‘junk ’ bonds, which offer a very high yield, but with a commensurately high probability of default.  Credit rating agencies Moodys and Standard & Poors offer credit ratings on most fixed interest stocks.  UK Government fixed interest stocks are often referred to as gilt-edged securities or gilts, indicating their high quality.

Currently, fixed-interest yields are low, reflecting low interest rates generally and the continuing demand from investing institutions.  Also over the last few years we have seen substantial yield compression, where the difference between the interest paid by the least and most risky stocks has reduced to historically low levels.  This is taken by many analysts to be a sign of a lack of value in the market.  Also fixed-interest yields are at a low level compared to share dividends. In the 80s and 90’s it was normal for UK Government stock to yield around twice as much as shares.  Today the ratio is around one and a half times. At the bottom of the recent slump, in early 2003, UK share dividend yields were almost exactly the same as gilt yields, making shares exceptionally cheap.

 

Forward price (see commodities)

 

Free float The amount of a company’s shares that are freely available to buy in the market. Shares owned by the company’s directors and their families, family trusts, employee share ownership schemes, etc are not available to be bought or sold. For some smaller, family-owned companies, the free float can be substantially less than the market capitalisation The smaller a company’s free float, the harder it is to invest, and the more a purchase or sale transaction is likely to move the share price.

 

FTSE-100 Well-known index of the shares of the hundred largest companies listed on the UK stock market.  Size is measured by market capitalization.  See also index.

 

Fund A more general term for a collective investment.

 

Futures (see derivatives)

 

Gilts Aka gilt-edged securities (see Fixed interest)

 

Gilt strips A derivative product which separates the two parts of an investment in gilts –the income stream and the capital return, and offers them separately to investors.

 

Go short (see hedge funds)

 

Golden Cross (see Chart analysis)

 

Growth Investment (see Style investment)

 

Guaranteed Income Bonds A type of investment normally offered by insurance companies, which offers investors a fixed rate of interest for a fixed period, with their capital returned in full at the end.  The capital is tied up for the whole period of the investment. Because the returns are known in advance, Guaranteed Income Bonds are a low risk product.  Their attractiveness depends on how the rates on offer compare to a standard deposit account.

 

Head and Shoulders (see Chart Analysis).

 

Hedge Fund The term ‘hedge fund’ derives from the phrase to ‘hedge your bets’ meaning to be in a position to gain if either of two possible outcomes should occur. Most hedge funds aim to have a low correlation with the stockmarket.

There are around twenty different hedge fund strategies.  By far the most common one is long-short equity.  To go short means to sell shares you don’t own.  For example, you might decide that Barclays shares were overvalued.  You would borrow some Barclays shares from an index-tracking fund, which holds all the shares in the index, for a consideration.  You then sell the shares to a third party.  Suppose the price of the shares was £5.00.  Your hunch turns out to be correct, Barclays share price falls, and before long you are in a position to buy the shares back at £4.50 each.  You then return them to their owner, and keep the difference. In a falling market, you have made a gain of 50p per share, less the costs of the transaction. To be long of a share is just another way of saying that you own it.  A long-short fund is long of some shares, which it owns, and short of others which it has sold, but doesn’t own.  You might, for example, be long HSBC and short Barclays. If you own an equivalent number of shares to the number you are short of, then the fund is said to be market neutral.  It goes without saying that a long-short fund, and even a market-neutral fund, can make very low returns, or even lose money.  As with other areas of fund management, the result has much to do with the manager’s skill. Other strategies involve trades which are entirely determined by computer programs.

Hedge fund managers often refer to funds which can own shares but not go short (including the vast majority of publicly available funds, and our own Wise Investment ones) as long only.

Another hedge fund strategy has become known as the carry trade.  The technique is to borrow money in a currency such as the Japanese yen, where interest rates are very low, and invest the money thus raised in a high interest-paying currency, such as the New Zealand dollar.  The returns come from the interest-rate differential, and some gains may be made on the currency. Some analysts believe that the weakness of the yen over the last year is due in part to the large number of carry-trade investors selling out of the currency.

Hedge fund fees are typically much higher than the fees for conventional unit trusts or OEICs.  There is typically an annual charge of 2.0% of the funds under management, plus a performance fee of 20% of all gains made.

There are now around ten thousand hedge funds in existence.  Many of the older and better-managed funds have been closed to new investment.

Companies are beginning to bring hedge fund offerings to the retail market. These tend to be multi-strategy funds-of funds.  As with all new funds, we prefer to see a good track record established before making recommendations.  It is also worth noting that returns across the entire hedge fund industry have been lower over 2005-6 than previously. Explanations range from possible over-saturation of some areas of the market, to a lack of market volatility.

 

Income shares (see Split-Capital Investment Trusts).

 

Independent Financial Adviser (IFA) Someone who is authorised by the FSA to give investment advice, and can offer products from the whole marketplace. Wise Investment is an IFA.

 

Index (plural indices) Indices are used to give a sense of the overall direction of a market which is made up of a large number of individual prices. The Retail Price Index (RPI), published monthly, is a measure of inflation, and is made up of the prices of different items most people spend money on, such as food, clothes, mortgage interest, etc. The number of stock market indices has grown hugely over the last century, and particularly in the last twenty years. The world’s first index was the Dow Jones Industrial Average, the ‘Dow’, constructed at the end of the nineteenth century by the same Dow who gave his name to Dow Theory.  The UK’s oldest index, the FT-30 dates back to 1935.  Today there are literally thousands of indices, covering stock, bond and commodity markets worldwide.

Early indices, such as the Dow and the FT 30 were unweighted.  Each share in the index carried an equal weight. Nearly all indices today, including the FTSE-100, are weighted, meaning that the shares of the largest companies have more effect on the movement of the index than the smaller ones.  The weighting is by market capitalisation.  Some commentators criticize this structure, which means that the UK’s giant companies such as Shell, BP, HSBC Glaxo and Vodafone have a disproportionate effect on the index, which in effect tracks a small group of companies, rather than the market as a whole. In the FTSE-100 index, for example, Shell, worth £115bn, has roughly thirty times the influence of Whitbread, worth £3.7bn.

 

Index-linked Mainly used to describe income payments from pensions or Permanent Health Insurance, which are linked to an index such as the Retail Price Index so that the purchasing power of the income is maintained over time.

 

Index-Linked Gilt A type of UK government stock, where both the interest payments and the capital returns are linked to the retail price index. See also fixed interest.

 

Index-trackers Funds which use a computer program to replicate the performance of an index, e.g. the FTSE-100 index.  The constituents of the index change every three months, as companies which have grown in size are included and ones which have shrunk are excluded. The trackers replicate the index by buying and selling accordingly.

Investing in index-tracking funds is also known as passive management, as opposed to active management.

Trackers are attractive to investors because of their (normally) low annual management fees. Also, most actively-managed funds are benchmarked against an index, and many fail to beat their benchmark.  A tracker fund with a low tracking error will only lag the market by the amount of its charges.

Our observation is that there are managers operating in nearly all the markets we cover who are able to beat their benchmark indices, after taking all charges into account, consistently over long periods of time.  We prefer good intelligent active managers to index-tracking funds, but there is no doubt that an index-tracking fund is better than a poor actively-managed fund, of which a large number exist.

 

Inflation The tendency of the prices of goods to rise. Rises in the prices of shares and property are often referred to as asset inflation.  We are used to price rises as the norm, but prices don’t always rise.  For example in England during the whole of the nineteenth century, and in Japan for about seven years until recently, prices fell.  This phenomenon is known as deflation.

Inflation and deflation both cause economic problems.  Inflation destroys the value of money, and hurts people who are on fixed incomes, and are unable to keep up.  It causes extra work for almost everyone (in the mid-70s I once bought a Mars Bar which had three prices stickers on it, as the price had risen twice during the time the bar had been in the shop - extra work for the shopkeeper).  It also makes real price rises much harder to see. When general inflation is 0%, everyone notices a 5% price rise. When inflation is 15%, it is hard for many people to see the additional 5% in a 20% price-rise. After a period of significant inflation, people develop inflationary expectations.  Pay bargaining becomes more difficult because negotiators want pay rises to factor in future inflation.

No cloud is without its silvery lining, though, and inflation is good for people who owe money, because the value of the money they owe quickly reduces.  Indeed, a period of inflation could be defined as a situation where the position of debtors is improved at the expense of savers.

Deflation is inflation in reverse.  Prices fall.  Deflation is associated with a stagnant economy.  During a time of deflation, there is no need to ‘buy now to beat the price rise’ and every reason to wait a bit longer till the price has fallen.  This is a time when the position of savers is improved at the expense of debtors.  The purchasing power of the saver’s money rises, even if (s)he isn’t receiving an interest payment, while the real value of the money the debtor owes keeps rising.

The cause of inflation is excessive demand, either for goods (price inflation) or assets (asset inflation).  The normal remedy for inflation is to raise interest rates, which makes borrowing money more expensive, and slows the rate of economic growth.  Conversely, the cure for deflation is to reduce interest rates, which should stimulate demand by making it more attractive to borrow money, and less attractive to hold cash in savings accounts. However, interest rates can only be reduced to zero, as happened in Japan recently, and beyond that the interest rate tool ceases to work. In this situation, governments often embark on large programmes of work to stimulate economic growth (in the case of Japan, the government spent trillions of yen on ‘bridges to nowhere’ which had no effect on the economy).

Inflation is normally measured by indices (see Index).  In the UK, price inflation is measured by the Retail Price Index (RPI) and wage inflation by the Average Earnings Index (AEI).  Over a long period of time, the AEI has risen faster than the RPI, meaning that real wages have risen.  It was thus a benefit for pensioners when the Government recently announced that the Basic State Pension would be increased in line with the AEI rather than by the RPI.  The inflation figures are published monthly.  Since 1992, the UK has had an inflation target which is currently 2%.  It is the task of the Bank of England  to raise or lower interest rates with a view to keeping inflation as near as possible to its target rate.  The Government considers that a low rate of inflation is better that none. During the 15 years of the inflation target, RPI inflation has never exceeded 5.0% However, this is as much due to conditions in the world economy, e.g. the deflationary effect of the import of cheap goods from China, as to UK Government’s policy.

 

Inflationary Expectations  (See Inflation)

 

Inflation Target (See Inflation)

 

Inheritance Tax (IHT) A tax on the estates of the deceased. Each individual has an exempt allowance, which is reviewed each year and is currently £285,000 (2006-7) Above that level, all assets are taxed at 40%.

Inheritance Tax has become controversial because it was initially conceived as a tax which would only affect the very richest people.  However, because the value of houses has increased much faster than the annual allowance, millions of families are now potentially liable to the tax. Rather than reforming the tax, or increasing the allowances, the Government has taken measures to clamp down on the increasing numbers of IHT avoidance schemes, many of which no longer work.

However, there are still legal ways to plan estates which can substantially reduce the tax liability. Please contact us if you would like to discuss your individual circumstances in complete confidence.

 

Initial Charge (See Unit Trust)

 

Initial Commission (See Commission)