Benchmarking

In order to quantify the success or otherwise of a fund manager, a metric in the form of a benchmark is usually stipulated. Examples of equity benchmarks would be broadly based equity indices. In fixed income, the construction of a benchmark portfolio is more complex, as individual securities need to be selected.

The characteristics of the chosen benchmark should be:

•  Specified in advance to the fund manager
• Unambiguous and appropriate to the type of fund being run. For example, the Dow Jones index in the US is far less representative of the US larger capitalisation stocks compared with the S&P 500 index
•  Liquid and easily measurable
•  Reflective of current investment opinions

Understanding the Different Products in the Capital Structure

What is Equity?

Equity capital, or financing, is money raised by a business in return for a share of ownership in the company. It is permanent capital (it does not need to be repaid). Ownership of equity gives the right (but not an automatic entitlement) to share in the profits of the business, after all other stakeholders (employees, debt holders, the taxman) have been paid. Companies are under no obligation to pay dividends, and dividends cannot be offset against tax.

Owning equity is the riskiest form of investment in a company. Ordinary shareholders are the last to be paid in the event of the business failing. As compensation for this risk, equity holders generally earn the highest return. Investors in public listed companies are free to sell their shares without requiring the approval of the company. The returns for investors are a combination of dividends and capital appreciation.