Investment Terms Everyone Uses - But Few Truly Understand

Even seasoned investors fall into the trap of using vague, misapplied, or simply misunderstood investment terms. Blame the industry for intending to confuse laypeople. Blame the advisors for parroting buzzwords. Or just blame the complexity of investing. Whatever the cause, unclear language can be a serious hurdle for investors.

In today’s market where global momentum defies fundamentals and portfolio decisions carry more weight than ever - it’s time for clarity.

This is a plain-language review of some of the investment terms that matter most. For board members, CIOs, consultants, and allocators alike, understanding these concepts properly, and explaining them clearly, is essential for better decisions and better outcomes.

Common terms: What they really mean and why that matters.

Alpha & Beta. What it is and isn’t.

Alpha isn’t just “outperformance”, it is excess return adjusted for risk. Beta doesn’t mean volatility; it measures how closely an investment tracks the broad market. Knowing the difference matters. It is maybe best explained this way: Alpha is the value an investment manager adds beyond market exposure. Beta is how much that investment moves with the market itself.

Volatility. Perception can be misleading.

Volatility is used to measure risk - but they’re not one in the same. Volatility measures price fluctuations, not the overall likelihood of loss. For example, the valuation of investments like private debt or equity are not updated daily, often marked-to-market – yet another term – only quarterly, thereby skewing their volatility lower yet not making them lower risk.

For example, certain private asset funds might appear “stable” simply because the valuations are updated infrequently, not because they are inherently low risk.

Hedging. Action over branding.

A hedge fund doesn't necessarily or always hedge. Hedging is often specific risk reduction, not only a general strategy. It is a valuable tool in a fund manager’s tool kit.

Passive versus Index. Simply not the same thing.

Not all index funds are passive, and not all passive strategies use indexes.

Reviewing these terms matters because each one is so often misunderstood and misused. Consider adding a brief explanation of your use of the term in your communications.

Key Phrases: What to reframe and explain better. 

Risk-adjusted returns. Sharpe is not optional.

In layman's terms this is meant to allow investors to choose between investments with the knowledge of how much return is generated for the risk taken. It is often quoted as a Sharpe ratio. Too many advertisements and too many investors only consider historical and expected returns without assessing the riskiness of the investment. In fact, a lower return investment may well be the optimal choice once risk and portfolio dynamics are considered. Evaluate both total and risk-adjusted historical and expected returns.

After-fee returns. Net over low.

Fees matter but returns matter more. Too many investors chase low-cost funds for their fees alone, rather than their actual performance. But what we really care about is what we get to keep. Net returns (after fees) should be the default measure for consideration, not gross expected return limited to low-fee offerings only. With good due diligence, a mix of higher and lower fee investments will likely deliver the optimal portfolio.

Absolute return. Strategy versus statistic.

This is both a strategy and the simple expression of an investment return without considering a benchmark or inflation. An absolute return investment strategy endeavours to produce a positive absolute return in all environments. It does not adhere to a specific benchmark, even if the fund may use a benchmark as a tool to demonstrate performance over time. These strategies tend to offer lower volatility and lower correlation to broad market indices because they focus on opportunities with a high probability of positive return, regardless of market direction. They can be portfolio stabilizers. Of note, many effective alternative investment strategies choose an absolute return approach.

Alternative investments. No longer Alt.

This one is a pet peeve. The term “alternative investments” suggests an outlier category - something outside the traditional buckets of stocks, bonds, and cash. But in truth, many alternatives fit within or enhance those buckets. Alternatives can include funds that use traditional assets like stocks or bonds in nontraditional ways, or entirely different assets which are not stocks or bonds, like infrastructure assets, wine, or music royalties. These so-called alternatives are no longer fringe. They’re proven. They have become essential. Ironically, the ‘alts’ label may now serve to protect the legacy dominance of traditional funds more than describe actual innovation.

Down or Downside Capture. Lower is better.

Unlike the terms immediately above, this one isn’t necessarily misunderstood, but it is a valuable statistic that is either unknown or not sufficiently prioritized. It is the portion of the index’s losses that a manager captures during periods when an index is declining. Obviously less capture of a decline is better, so a low or ideally negative down capture stat demonstrates the coveted ability to protect capital.

These terms are essential building blocks for an optimal portfolio. The rest of the well-intentioned asset allocation process will be skewed if these inputs are not effectively applied.

Powerful concepts: Often feared, too rarely understood, yet critical. Concepts that can unlock highest-value opportunities.

Liquidity. Comes in different forms.

Within an investment fund there may be specific anytime, daily, monthly or other time constraints to selling the fund. Those parameters should not be confused with the nature of the assets in the fund which may be illiquid - as in private debt or private equity, or quite liquid - using public debt and equity securities. A fund with a minimum hold period may in fact hold public, tradable, and liquid investments that typically lower the risk profile. 

Leverage. A tool, not a red flag.

Financial leverage most commonly refers to the use of borrowed money to amplify investment returns. All of us use leverage in our personal lives, namely credit cards, mortgages, and car loans. Banks and private equity funds inherently deploy leverage - which society has deemed appropriate.

Yet within investments, leverage has often been misunderstood or stigmatized. High-profile blowups and financial headlines have shaped too many perspectives, overshadowing the thoughtful, disciplined ways leverage can be used to improve outcomes. Used appropriately, within funds or portfolios, leverage can open the door to more compelling opportunities than unlevered investments alone, all while staying within acceptable risk parameters.

Jargon isn’t inherently bad. But when it’s misunderstood - or misused - it becomes a barrier to smart decision-making. As stewards of capital, our fiduciary responsibility isn’t just to understand these terms, but to explain and them clearly, and apply them. In a world of complexity, clarity builds trust, and it drives better portfolios.

If you get most of these right, you’re probably winning.

Kevin Foley is a Managing Director, Institutional Clients at YTM Capital. YTM Capital is a Canadian asset manager focused on “better fixed income solutions” specializing in Credit and Mortgage funds. Kevin is the former Head of Credit Trading, Syndication, Sales and Research at a major Canadian bank. Kevin sits on several Canadian Foundation Boards and Investment Committees.