Up-to-the-Minute Terms Every Investor Should Know

By PAUL J. LIM

April 4, 2000 12 AM PT

TIMES STAFF WRITER

In this new era of investing, there are new terms to get to know. Below is a glossary of some of those terms, along with some important terms that have been around awhile.

(Definitions for Morningstar’s mutual fund categories discussed throughout this section are on pages S14-S17.)

* Actively managed funds. A mutual fund in which the fund manager is allowed to use his or her discretion to buy, sell or hold investments in the portfolio. Most funds are actively managed.

* Balanced funds. Sometimes called “hybrid” funds, balanced portfolios are a type of mutual fund that invests in a combination of stocks and bonds. They are considered safer and more conservative than pure equity funds.

Traditionally, balanced funds invest approximately 60% of their assets in stocks while keeping the remaining 40% in bonds. Many balanced funds have upped their exposure to stocks, however.

* B2B funds. “Business-to-business” funds. Expected to be available shortly, these will be a specialized form of technology sector fund that primarily seeks out Internet companies working on business-to-business solutions.

* Basket securities. An umbrella term used to describe new types of securities that give investors exposure to an entire portfolio of stocks through a single purchase--much like a mutual fund. As a result, many view basket securities as competitors to funds.

Unlike traditional open-end funds, though, basket securities are exchange-traded. That means investors can buy or sell shares throughout the day--not just once a day at the market closing price. To invest in a basket security, you must have access to a brokerage account and pay a commission. Basket securities trade on the American Stock Exchange. (See Diamonds, HOLDRs, WEBS and SPDRs.)

* Blue chips. A nickname for big, established companies.

* Concentrated funds. Also referred to as “focused” funds. Concentrated funds tend to invest in relatively few stocks in hopes of generating outsize gains. Whereas the average domestic stock fund invests in 143 stocks, a concentrated fund may invest in only 20 to 40 of the fund manager’s “best ideas.”

* Diamonds. (Ticker symbol: DIA) A nickname for a type of investment trust, or basket security, whose holdings represent all 30 blue-chip stocks in the famed Dow Jones industrial average. At any moment in time, shares of Diamonds will be priced at about 1/100th of the value of the Dow industrials.

* Diversified funds. A mutual fund that invests in a wide array of different types of stocks. Unlike concentrated funds, diversified funds tend to invest in a large number of holdings--often more than 100 securities--to reduce risk.

* Dividends. Payments that corporations distribute to shareholders. Although companies historically have used dividends to share profits and entice shareholders to buy their stock, fewer firms pay out dividends today, choosing instead to use the capital to buy back shares, reinvest in the company--or invest in other companies. Some dividend-oriented mutual funds have loosened their investment rules to adapt to these trends.

* Enhanced funds. These funds try to deliver 125%, 150% and sometimes even 200% of the movements of a particular market index.

* Equity-income funds. A conservative type of stock fund that seeks out dividend income as well as capital appreciation. These funds are often associated with “value” investing.

The terms “equity-income,” “growth and income,” “growth” and “aggressive growth” are part of an old mutual fund classification system that Lipper Inc. popularized decades ago. Lipper has since changed to a system more like the one used by Morningstar in this section.

* Exchange-traded funds. (ETFs) A new breed of basket security. ETFs are open-end stock index funds whose shares are listed on an exchange--and thus can be bought and sold intraday like a stock. San Francisco-based Barclays Global Investors has filed papers to launch up to 51 new ETFs that would track every conceivable index ranging from the Dow Jones Consumer Non-Cyclical index to the S&P;/Toronto Stock Exchange 60 index.

ETFs create shares as they are needed and are not to be confused with “closed-end” mutual funds, which have a fixed number of shares and can trade higher (at a premium) or lower (at a discount) than the value of the underlying portfolio.

* Growth funds. Stock mutual funds that seek out shares of companies with rapidly expanding earnings and/or revenue.

* Growth and income funds. Diversified funds that seek out both growth and dividend income.

* HOLDRs. A new type of basket security created by Merrill Lynch to reflect a specific basket of stocks. HOLDRs stands for holding company depositary receipts.

In addition to the two original HOLDRs--one representing a basket of 20 Internet stocks (ticker: HHH) and another representing 20 biotechnology stocks (BBH)--at least five others recently have been created, included a pharmaceuticals HOLDRs (PPH) and a telecom HOLDRs (TTH).

Unlike other basket securities, in which the shareholder owns units of a security that reflect and track a basket of stocks, HOLDRs give you actual beneficial ownership of the underlying stocks in the basket. There’s an inherent tax advantage with this structure, analysts say. For instance, merely redeeming the HOLDRs--and accepting the underlying stocks--is not a taxable event.

* Index fund. Passively managed portfolios that simply track an existing stock market benchmark, such as the Standard & Poor’s 500 index of blue-chip stocks. Because it takes relatively little work to manage an index fund, these portfolios often have a low annual expense ratio.

* Internet funds. A specialized type of technology sector fund that invests primarily or exclusively in companies working on--or benefiting from--the Internet.

* Managed accounts. Also referred to as “separate accounts.” These accounts are designed for high-net-worth individuals--those with at least $500,000 to $1 million in investable assets. In a managed account, individual investors buy the services of a professional money manager, who invests money for them.

In a managed account, unlike a mutual fund, you are the sole shareholder. Therefore, the buying and selling activities of fellow shareholders do not affect the way your portfolio manager invests.

* Market-neutral funds. A type of stock fund designed to make money whether the stock market advances or declines. These funds do this by placing equal and simultaneous bets on and against the market. Because the market has been rising much more than falling in recent years, investors have recently been better off with a straight stock fund.

* Momentum investing. An investment strategy in which investors pile into stocks that have already gone up, on the bet that they’ll keep going up. The idea is that money flowing into stocks that have already done well will keep them doing well for some time. The danger is that it’s impossible to predict when momentum will shift.

* New-economy funds. A term that refers to funds that invest in a cross-section of technology, telecommunications and other stocks that stand to benefit from the developing technology- and information-driven economy.

* QQQ shares. A nickname--and ticker symbol--for shares of the investment trust, or basket security, that represents all the stocks in the Nasdaq 100 index (representing the largest nonfinancial stocks in the Nasdaq composite index).

Like Diamonds and SPDRs, QQQ shares can be bought and sold intraday. Each share is priced at about 1/40th the value of the Nasdaq 100.

* Sector funds. Mutual funds that invest in a single sector of the economy--such as financial services, health care, technology and utilities.

* Self-directed brokerage window. An investment option within a company-sponsored 401(k) retirement plan or similar account that gives the investor access not just to a single mutual fund, but to a discount broker.

Through this investment option, a plan participant can use his or her retirement savings to invest in thousands of stocks and hundreds of mutual funds or hybrid investment products. In 1995, fewer than 1% offered this feature. Today, about 7% do.

* Short funds. Mutual funds that make bets that the stock market (or at least certain stocks) will fall in value--and then try to profit from those losses.

Some funds do this by “shorting” a stock. Short selling is the reverse of the more typical buy-low, sell-higher approach to investing. Here, you borrow a security from a brokerage and then sell it on the open market. When the price of the stock tumbles, you can then “repurchase” the security, hopefully at much lower prices. You then return the security to the brokerage, pocketing the difference between the higher price at which you borrowed the shares and the lower price at which you repurchased them.

Other short funds achieve similar results by investing in futures contracts or other securities.

Examples of short funds include Rydex Arktos and the ProFunds Bear fund. Because of the rising bull market, however, these funds have posted some of the worst records in recent years.

* SPDRs. Short for Standard & Poor’s depositary receipts.

Commonly referred to as “spiders,” these exchange-traded securities represent all 500 stocks in the Standard & Poor’s 500 index of blue-chip stocks.

SPDRs can be bought or sold throughout the day, unlike S&P; 500 index mutual funds. Like other basket securities, SPDRs (ticker: SPY) are listed on the American Stock Exchange.

* Tax-managed funds. A growing breed of stock fund that seeks capital appreciation--but tries to do so in a tax-efficient or tax-managed way.

For instance, if a tax-managed fund decides to sell a stock it has owned for, say, 360 days, it might hang on a week longer to ensure that profits on the investment are taxed as less expensive long-term capital gains rather than as short-term gains. Or if the fund wants to sell a winning stock, it might simultaneously sell a losing stock in the portfolio to match up--and therefore offset--gains with losses.

* Twice-daily pricing. The vast majority of funds price once a day--at the market close. That means if investors want to buy or sell shares of a fund, they can only do so once a day, at the day’s closing price.

Some fund companies, though, such as Rydex, are working on launching portfolios that can be priced priced twice a day.

* WEBs. Stands for “World Equity Benchmark shares.”

Think of them as exchange-traded index funds that reflect the stock market of a single country. Currently, there are 17 WEBs representing the markets of developed countries ranging from the Australia to Britain. There are plans to create several new WEBs that will track various emerging markets indexes.

* Wrap accounts. See managed accounts.

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New Choices

In recent years, a number of new investment products have been created for individual investors--some by mutual fund companies, others by competitors to funds. Today, an investor who wants to build a total portfolio need not rely solely on mutual funds.

Want to Index?

Old Options New Options

Vanguard Exchange-traded funds

SPDRs

Diamonds

QQQ shares

Are you a big risk-taker?

Old Options New Options

Tech funds Nasdaq 100 funds

Foreign funds Emerging markets WEBs

Merrill Lynch sector HOLDRs

Enhanced index funds