CPM Investing LLC - Research Publications
The following terms are important to understanding general investing and, more specifically, the Focused 15 approach to investing. The more fundamental terms are listed first, and the terms build upon each other.
Stock - A single share of a stock represents ownership of a corporation proportional to the total number of shares issued. Shares of a company are sold as stocks to the public to raise capital for the company. Shareholders can trade their shares for a price determined by the market value of the share.
Equities - Also known as common stocks. Refers to ownership shares of a publicly traded company. The terms "Equities" and "Stocks" are often used interchangeably.
Bonds - Debt instrument of a company or government. A bond pays a fixed rate of interest. The terms "Bonds" and "Fixed Income" are often used interchangeably.
Index - A measure of typical performance for a group of securities (often stocks or bonds) whose prices move in similar ways. The most well-known of the indexes are said to track the "market." Examples of such indexes include the Dow Jones Industrial Average (30 large-company stocks), the S&P 500 (500 large-company stocks), and the Russell 2000 Small Company Index (2000 small-company stocks). There are hundreds of indexes in the world. Their creators are businesses originally focused creating benchmarks for the evaluation of investment decisions made by investment managers. Typically, when creating a new index, the index company seeks to create simple and easy communicated ways of determining which of the many available securities (like stocks in the stock market) should be included in the index and the weights each security should be given in the index. For example, over 100 years ago, the Dow Jones publishing company wanted a simple way of saying what the market did each day. They decided to select 30 of the most important companies in the US and average their prices together as a measure of the overall stock market performance. The number of companies they selected to include, 30, was arbitrary. The Dow Jones Industrial Average has been widely reported in the news for many decades. Over the years, other index companies sprang up and decided to include more stocks, which resulted in the S&P 500 and the Russell 1000. Since these indexes are selecting from the same pool of US stocks, these indexes are highly correlated. Index companies have developed many other ways of grouping different types of securities. Today there are hundreds of indexes that track the performance of different groups of securities from all around the world.
Index fund - A mutual fund or ETF that follows preset rules in order to track a specific index. An index fund typically invests in all securities in the index (for example, the DJIA). Index funds are popular because many professional managers have trouble producing better returns than these market averages over time, they are fully transparent (it is easy to see an index's holdings and their weights), and indexes funds are inexpensive.
Asset Class - A term used loosely to refer to a group of securities (usually stocks, bonds or some other broad category of securities). The performance of an asset class is often measured by a published index, such as the Dow Jones Industrial Average (DJIA), or the Barclays Aggregate Bond index (AGG), which tracks investment grade bonds. As new indexes are developed for more refined groups of securities, these more focused groups are at times called assets classes. The stocks of Ford, GM, and Toyota belong to the "autos" class of stocks. They could also be in the "large company" class of stocks.
Stock/Security Selection - A way that many investment managers seek to outperform the market index. In their portfolios of stocks, they will determine which stocks are most attractive and weight them more heavily in their portfolios than they are in the index. For example, they will evaluate all the companies within a sector, like autos, and decide whether to give Ford, GM, or Toyota more weight in the portfolio.
Policy Allocation - An industry term referring to the mix of major asset classes that is determined for a long time period: many years. A commonly used policy allocation is 60% Equities and 40% Bonds.
Active Asset Allocation or Rotation - A way that some investment managers seek to outperform the policy allocation. In their portfolios, they will determine which asset classes are most attractive and overweight them relative to a policy mix. They may determine to overweight equities relative to the policy allocation, holding 70% instead of the policy weight of 60%. Many use the terms asset allocation and asset rotation interchangeably. Both mean moving money among asset classes.
Mutual fund – An investment fund that pools capital from many different investors to purchase a portfolio of securities, providing diversification. Mutual fund shares are traded after the market close.
ETF (Exchange Traded Fund) - One can buy shares of an ETF, and these are traded during the trading day. They are designed by their provider (e.g., BlackRock, JP Morgan) to track the returns of a published index (e.g., DJIA). This enables investors to buy stocks in all 30 DJIA without having to buy each company's stock separately. ETF returns are similar to the returns of the index they track, less the fees paid to the provider and seller of the ETF. ETFs make moving money from one asset class to another much easier. In many ETFs, the ETF issuer (or sponsor) holds all the securities in the index being tracked.
Model Portfolio - A mix of index funds and/or ETFs weighted in a way that favors the resilient asset class indexes and avoids the vulnerable. One should select a model portfolio that will be used for each account, and then trade to maintain alignment between the account and the model portfolio.
Target Weights - The weights, in terms of percent of the total account, that should be held in each of the asset class index funds and/or ETFs for a particular model portfolio. These are sent out each week, typically in the middle of the week. The performance simulations assume that trades are done at the close of trading on the following Friday.
Upper Risk Mix - Includes the same selection of ETFs included in the model portfolio but held at aggressive (high exposure to stocks) weights over time. In many of our model portfolios, the default weight of the asset classes (i.e., stocks, bonds) is 70/30. Within these broad classes, they are default weights for each ETF within that asset class. The Upper Risk Mix shows the weights and these can be seen on the right side of the model portfolio's detail page in the weekly publication. The returns of the default portfolio serve as a reference point the model portfolio.
Leverage - In this context, leverage refers to the magnification of returns (both positive and negative) in some ETFs. The ETFs are labelled as providing, for example, "2x" the returns of the underlying index. We use the ETF "UST" in most portfolios. This provides two times the returns of the US 7-10 year Treasury bond index. The ETF provider typically arranges with a large bank to provide the extra return for a small fee.
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