The ETF (which stands for Exchange-Traded Fund) industry is awash with acronyms and abbreviations, and although they can be great for getting a point across quickly, they're not much help if you don't know what they mean to begin with. But never fear! We've busted the jargon with a list of some of the most commonly-used terms and phrases related to ETFs, so you can get your head around the confusing terminology once and for all.

A

Actively managed

An actively managed ETF has a portfolio manager who makes active decisions about what to buy, rather than passively tracking an index or benchmark where by definition you just buy everything. These typically have higher fees than passive ETFs as you’re paying extra for the time and skills of the portfolio manager who is making subjective decisions based on research and preferences.

Alpha

Alpha is the term given to the amount by which an ETF outperforms an index or benchmark, usually used when talking about actively managed ETFs which have achieved better returns than a passive ETF merely tracking the market would have produced over the same period. So if the FTSE 100 returns 5% but your portfolio returns 6%, it has delivered 1% of alpha.

Asset

Assets are the building blocks that make up an ETF. These are the things that an ETF is invested in, such as shares, bonds, property or cash. How an ETF’s assets are allocated determines the overall risk and return potential of your investment.

Asset type

The asset type – or ‘class’ - is the classification used to define the nature of the assets in an ETF, such as shares, bonds or cash.

AUM

AUM stands for ‘Assets Under Management’ and refers to the total value of an ETF. In other words, it shows how much investor money has been put into the ETF, based on today’s valuations. If 1,000 investors put £1 into an ETF this week, there will be £1,000 AUM. And if the market goes up by 10% next week, then the AUM will rise to £1,100.

B

Basis points

Basis points (bps) are a unit of measurement equal to 1/100th of a percentage point often used when describing the fees of an ETF. So 50 basis points means 0.5%.

Beta

Beta is the performance of an ETF relative to the market it accesses. For example, an ETF with a beta of 1 follows the exact performance of the market. The higher the beta, the more volatile the price movement is.

Benchmark

A benchmark is the standard against which an ETF is measured, for example, to calculate relative performance or risk exposure. It’s a comparator – the bog average of any sort of fund or investment.

Bid

The bid spread is the difference in price between what someone is willing to buy an ETF for and what someone is willing to sell it for. The wider the bid, the more expensive it is to trade that particular ETF. Not usually a problem for large mainstream ETFs.

Bond

A bond is a type of security - usually issued by a government, company or agency and acts like a loan - that pays a defined rate of interest (also known as a ‘coupon’) over a set period of time. At the end of this period, the initial amount is repaid in full on top of the accumulated interest payments.

C

Closed-ended fund

A closed-ended fund is a fund which has a fixed number of shares. These often trade at a premium or discount relative to their net asset value due to the finite supply of available shares, and typically issue larger and more consistent dividends than other types of fund. So for example, if there are only 100,000 shares available, and loads of people want them, this will have the effect of pushing the price up. Sometimes beyond what the total collection of shares inside it is worth.

Commodity

A commodity is a basic physical asset, such as wheat, gold or oil. ‘Hard’ commodities refer to assets which must be mined or extracted, like gold or oil, whereas ‘soft’ commodities are farmed or grown, such as wheat or coffee.

Creation/Redemption

A mechanism unique to ETF, creation/redemption refers to the process of creating new ETF shares. 'Creation' involves the buying of all the underlying assets and 'wrapping' them into the ETF which is eventually sold on the stock market, while 'redemption' is the process in which the ETF is ‘unwrapped’ back into the individual assets it is made up of. The ability to create and redeem shares in this way keeps the price of an ETF in line with the underlying NAV (see below) of its constituent parts.

Custodian

The custodian is the institution - usually a large bank - responsible for holding all the securities in an ETF on behalf of investors. They are legally responsible for the safekeeping of an ETF’s securities, but sometimes offer additional services such as collecting dividends and administering accounts. This protects investors by ringfencing their money away from the investment manager.

D

Derivatives

A derivative is a financial agreement made between two or more parties based on the value of an underlying asset, index or benchmark. It is a way to access the rise or fall in any share price, or commodity price, for example, without actually owning it.

Diversification

Diversification is the process of spreading the assets in an ETF across different asset classes, such as partially in shares and partially in bonds, in order to spread out risk. In other words, don’t put all your eggs in one basket.

E

Emerging market

An emerging market is a country with an economy considered to be at an earlier stage of development than a more established country – e.g. India compared to the USA. Emerging market investments are usually considered to carry more risk, often because there is less information, or less strong governance, around.

ESG

An acronym for ‘Environmental, Social and Governance’, ESG is a broad set of metrics often used to measure the perceived sustainability of an investment. ESG is increasingly popular as a method of assessing the environmental and social impact of an ETF, particularly for investors looking for ‘green’ or ‘impact’ investments.

ETF

An ETF (Exchange Traded Fund) is a fund made up of a number of assets which can be bought and sold on the stock market in the same way as you would with individual shares. ETFs can invest in everything from shares to bonds, commodities, currencies, property and even derivatives, as well as a mixture of any of these different assets. Think of it like an investment ‘playlist’ – an easy way to access a collection of things.

Exposure

Exposure is the proportion of an ETF invested in a sector, asset class or region, usually expressed as a percentage of the overall portfolio. For example, an ETF with 75% exposure to China would have 75% of its assets invested in products related to or in China.

F

Fixed income

Fixed income is a broad asset class which pays investors a regular income, e.g. bonds, either in the form of a fixed amount or one that tracks a benchmark rate. Fixed income investments do not fluctuate like dividends or move in line with inflation.

G

Gilt

A gilt is a fixed income bond issued by the UK government.

H

High yield bond

A high yield bond is a bond which is determined to have a higher risk of default compared to other bonds. They have a higher yield because investors often get higher coupon payments to compensate for taking on the additional risk.

I

Index

An index is a basket of assets or securities designed to represent a market or submarket. For example, the FTSE 100 is representative of the 100 largest companies listed on the London Stock Exchange by market capitalisation. Indices track the performance of the relative market and are often used as a benchmark for investors or portfolio managers.

IPO

An IPO (Initial Public Offering) refers to the event when shares in a private company are listed on a stock exchange and made available for investors to purchase for the first time.

L

Liquidity

Liquidity is how quickly an asset can be converted into cash during the trade process without affecting its price. The higher the liquidity, the more efficient and less costly it will be to trade. An asset with low liquidity, on the other hand, will have higher trading costs and could take longer to trade.

M

Market maker

A market maker, or ‘liquidity provider’, is an individual or institution who facilitates trading by quoting the buy and sell prices of an asset or fund. They ensure that the trading process remains smooth for all parties and can provide liquidity in doing so.

Momentum

The momentum of an asset or fund refers to the concept that recent good performance is likely to continue. The investment is ’on a roll’.

Multi asset

Multi asset is a term used to describe funds that contain more than one type of asset class – e.g. shares and property – and are particularly useful for investors looking to diversify their portfolio and gain exposure to multiple types of asset. They're like a ready-meal and you can literally buy this one thing – and job done. It’s fully diversified and has thousands (typically) of investments in it, from all around the world. Your job is to pick the ‘risk level’ which usually depends on your timeframes. The shorter the timeframe, the lower the risk you can afford to take.

N

NAV

The NAV (Net Asset Value) of an ETF is the total value of all the assets included in the fund at a given point in time.

O

Open-ended funds

Open-ended funds have an unlimited supply of shares available to trade, unlike the fixed number that closed-ended funds do. Most ETFs are open-ended.

P

Passive

Passive is used to describe an ETF which is designed to track an index or benchmark, as opposed to an active ETF, where the fund manager is able to make investment decisions at their discretion in order to try to outperform a benchmark.

Physical ETF

A physical ETF is one which directly invests in the same assets as the index it is designed to track. E.g. a physical FTSE 100 ETF would own shares of all, or at least some of, the 100 companies included in the FTSE 100. A physical Gold ETF will actually own real gold. Great big lumps of the stuff. Physical ETFs are the most readily available and are typically less risky than synthetic ETFs.

S

Synthetic ETF

A synthetic ETF does not invest directly in assets, like physical ETFs, but via derivatives. This is typically for the purpose of gaining exposure to hard-to-access assets, such as crude oil. In this case, instead of directly owning barrels of crude oil, a synthetic ETF may hold oil futures contracts. This agreement is facilitated by a ‘counterparty’ - usually a bank - who would be obligated to pay an agreed level of return back to the ETF’s shareholders once oil reaches a certain price.

T

TER

This is short for 'Total Expense Ratio', which is a measure of the total cost of a fund to an investor. It can include fees and charges such as trading fees, legal fees, auditor fees, and other expenses involved in the running of the fund. The TER is important for one key reason - it affects your returns. Say for example that your fund generates returns of 5% for the year, if the TER is 4%, you'd only get to take home 1% in profit. Actively managed funds tend to have a higher TER to cover the cost of more personnel, whereas passive funds typically have a lower TER as they cost much less to run.

U

UCITS

UCITS (Undertakings for Collective Investments in Transferable Securities) is the acronym for the European regulatory framework that is used to determine whether an investment vehicle, such as an ETF, can legally be marketed across the European Union.

V

Volatility

Volatility describes the price movement of an investment. High volatility indicates frequent and significant price movement, whereas low volatility denotes less frequent or severe fluctuations in price. In investment speak, risk actually means high volatility.

Y

Yield

The yield is the return on an investment, usually expressed as a percentage of the total price. So for example, if the yield on a bond is 5%, this means an investor with £100 in that bond, would get £5 of income a year.