The glossary explains the most common terms associated with investments and returns on investments.
Terms related to investments
Beta coefficient measures the market risk of shares. When beta is one, the return on the share changes at the same rate as the average return on the market. When the coefficient is two, the investment risk is greater and the return varies so that the average is double the return on the market. If beta is under one, the share has a lower risk and changes on the market have on average a smaller impact on the return.
A loan issued by a company, a multinational organization, a government or some other actor in the public sector, which in most cases is marketable. The loan sum is divided into debt instruments that investors can subscribe to, or purchase, from the banks that manage the issue. Examples of bonds in Finland are bond loans and debenture loans.
Commodity investments refer to investments, for instance, in raw materials, agricultural products and energy. The return on these investments is based solely on price changes. The investor does not earn income comparable to dividends or interest. Commodity investments are often made as derivative investments.
A derivative is a financial instrument (contract) whose value is based on the value of some other financial instrument (an instrument underlying the derivative). The most common derivative groups are interest rate, equity and commodity derivatives. Derivatives can be used for both taking risks and hedging against risks. When drawing up a derivative contract, the parties agree on a future transaction that can be implemented by providing the instrument underlying the derivative (physical implementation) or by providing the monetary value of the derivative contract (monetary implementation).
Quoted shares are traded on the stock exchange. Unquoted shares are shares that are not traded publicly.
Fixed-income investments include money market instruments, bonds, and investment and TyEL premium lending.
A fund that in its investment strategy seeks an absolute return regardless of the market situation. Thus, the goal of a hedge fund is a market-neutral investment. In other words, the purpose is to eliminate the market risk and bring the beta coefficient to zero. In their investments, hedge funds use various strategies and techniques, such as derivatives, leveraging and short selling.
As indicated by its name, a hybrid fund is a mix of equity funds and fixed-income funds. Using the distribution defined by its rules, the fund invests in both investment types. The risk inherent in a hybrid fund is lower than that of an equity fund but correspondingly higher than the risk of a pure fixed-income fund.
Infrastructure can be divided into two parts: economic and social infrastructure. The former includes roads, airports, power grids and telecommunications, while the latter refers to schools, libraries and prisons. Investment in infrastructure can take two different forms. The first way is direct investment by owning real property or by owing a company that produces a construction project. The second way is to invest in infrastructure indirectly via funds.
Investment loans are loans granted by authorized pension providers against debt instruments at any given time. Investment loans resemble loans granted by banks against debt instruments, where the interest and maturity vary depending on the use of the loan. Investment loans are divided into two groups: loans granted to outside real estate companies and loans granted to pension providers’ own real estate companies.
At any given time, the investment portfolio comprises money market instruments, bonds, convertible debt securities, shares and share-type investments, real estate and shares in real estate, and the loan portfolio.
Interest rates for new loans
TyEL reference rates were taken into use for premium lending in 1997. The interest on a TyEL loan is calculated from the TyEL reference rates depending on the maturity, the interest determination period, the repayment method and the collateral.
Money market investment
Money market investments are fixed-income investments with a maturity not exceeding one year.
Private equity investment
Investment made on the stock exchange in an unquoted company that needs financing for its early-stage growth (seed funding, venture capital) or a new growth phase, or that the current shareholders are ready to sell to a great extent. Private equity investments are usually made through private equity funds. The funds select the final investment targets.
Responsible investment can be divided into three basic pillars: environmental responsibility, social responsibility and good governance. Together these three are also known as the ESG factors (Environment, Society and Governance). The ESG factors are incorporated into investment processes and ownership practices so that consideration of these factors improves the risk-return ratio of the investment portfolio. In practice, responsible investment aims:
- indirectly to reduce the use of fossil fuels;
- to increase the popularity of renewable energy;
- to respect labour and human rights; and
- to promote the good governance of companies, for instance by increasing the transparency of their operations.
TyEL premium lending
TyEL premium lending is based on the insurance terms of the insurance contract under the Employees Pension Act (TyEL). Part of the TyEL contributions paid by the employer are funded and the policyholder has the right to reborrow part of the fund accumulated. The maturity of the loans is 1 to 10 years. The borrower must provide collateral for the loan.
Terms related to investment returns
Current value return
The current value return is the return concept used. The current value return is obtained by adding the change in valuation differences during the year to the euro-denominated return minus investment expenses, as shown in the profit and loss account. The rate of return is obtained by dividing this euro-denominated return by the euro-denominated market value of the investment assets.
The market value of the investment assets, used as the divisor, can be calculated accurately by considering the time that the capital has been tied up in the asset category in question.
As terms, investment income and investment result are very similar but they mean two very different things.
The investment result is obtained from the investment income shown by the profit and loss account, by deducting from it the income that must be funded and by adding to it the change in valuation differences. Thus, for instance, the investment result can be negative even though the investment income is clearly positive.
The calculation of the pension liability and the return requirement on technical provisions are not applied to public-sector pension providers.
Nominal return refers to the total return on a certain investment instrument. For example in an equity investment, the investor’s total return includes dividends and the share price trend but also the costs arising from the investment.
Real return takes inflation into account as a factor reducing the total return. Real return reflects the increase in buying power generated by the return; in other words, how much more goods and services consumer A can afford to consume. Real return is very practical for comparing returns from different periods. Return figures adjusted for inflation therefore should always be used when making comparisons between periods.
Terms related to Solvency
Terms related to Solvency can be found from the glossary of actuarial terms.