Quick Guide To Common Financial Terms

April 06, 2018

This article is part of a regular series of thought leadership pieces from some of the more influential ETF strategists in the money management industry. Today's article is by David Haviland, managing partner and portfolio manager of Beaumont Capital Management, based in Needham, Massachusetts.

April is Financial Literacy Month, and for good reason. We all know the costs of lack of financial preparedness, especially as our country ages into retirement.

Perhaps the first step to financial literacy is understanding commonly used terms and financial concepts in our industry. With that in mind, we put together a glossary of financial terms meant as a tool for individual investors and financial advisors.

Active Management

Any strategy that uses human discretion to decide what the portfolio should own. The manager(s) generally employs some combination of fundamental, quantitative or technical research in conjunction with their experience, knowledge and judgment to try to find opportunities greater than the market. The fees are typically higher than passive, as you are paying the managers for their work.


A measure of excess return, usually expressed as a percentage. A positive excess return means that, for the risk taken, the reward received was greater than expected. In the industry, it is commonly accepted that a manager with positive alpha has added value beyond what was available to a passive investor.


This is used to determine the risk/reward profile of an investment relative to the market as a whole. If the beta is greater than 1, the investment is deemed riskier than the market as a whole; if less than 1, then it is less risky than the market. A beta of 1.2 implies that if the index goes up or down 10%, the investment in question can be expected to go up or down 12%.

Closet Indexing

This describes funds that claim to actively purchase investments, but wind up with a portfolio not much different from the benchmark. By doing this, portfolio managers are able to achieve returns similar to an underlying benchmark, like the S&P 500 Index, without exactly replicating the index.


The measurement of an investment’s total decline from its previous peak for a particular period of time. Drawdown is a useful tool to help determine an individual’s risk tolerance. This statistic can help investors gauge their risk appetite as previous large drawdowns, or peak-to-trough declines, may repeat in the future. Since most investors’ primary worry is how much they can lose in a bear market, this is often a good measure of an investment’s appropriateness to each investor. How large of a drawdown can your client handle before they begin to panic or react with emotion?

Fundamental Research

A method of evaluating an investment in an attempt to measure its intrinsic value, by examining related economic, financial and other qualitative and quantitative factors. The end goal is to use real, public data including macro- and microeconomic factors, like the overall economy and company management, respectively, to decide if the investment is over- or undervalued.

Passive Management

Often synonymous with index investing. By simply investing in the holdings of the index the strategy follows, the buy and sell decisions are not discretionary; rather, they’re based on the rules of the index. If an index fund you invest in enters a period of failure, your portfolio will also succumb to the market failure. Costs are typically low, as there is little management of the portfolio.


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