Glossary

Absolute risk: Variation in absolute returns, often measured as a standard deviation. Also known as volatility.

Active management: The management of a portfolio where the objective is to diverge from a benchmark (i.e. to take active positions) in order to improve return on investment. The difference between active and enhanced mandates is that the latter permits a more limited deviation from the benchmark.

Active position: Deviations in composition between an actual portfolio and its benchmark. If the actual portfolio is composed of 55% equities and the benchmark contains 60% equities, the active position is -5%.

Active return: The difference in absolute return between a portfolio and its benchmark. The Fund calls its comparative index a benchmark index.

Active risk: The risk that arises due to active management. Most often measured at the standard deviation between actual return and the benchmark return (i.e. the standard deviation of active return), which is also known as tracking error.

ALM: Asset Liability Modelling. A study aimed at determining the optimal long-term allocation of investment assets in order to meet the Fund’s commitments. The study is based on the Fund’s obligations and the expected return, risk and correlations of different asset classes.

Automatic balancing: Should the pension system’s liabilities exceed its assets (implying a balance ratio of less than 1) the pensions can no longer be indexed with growth in average income, as intended. For example, with a balance ratio of 0.98 (i.e. assets are 2% lower than liabilities) the pension benefits will be automatically reduced by 2% during the year. When and if the balance ratio rises back to a value exceeding 1, the pension benefits will be returned to their original levels. However, no repayment is made for benefits lost in earlier years.

Back test: A method for determining the predictive validity of an investment strategy using historical data. For example, back testing can be used to test the profits a strategy would have generated if it had been followed over the past 10 years.

Balance ratio: The ratio between total assets and liabilities in the pension system. Should the pension system’s liabilities exceed its assets (implying a balance ratio of less than 1) the pensions can no longer be indexed with growth in average income, as intended. For example, with a balance ratio of 0.98 (i.e. assets are 2% lower than liabilities) the pension benefits will be automatically reduced by 2% during the year. When and if the balance ratio rises back to a value exceeding 1, the pension benefits will be returned to their original levels. However, no repayment is made for benefits lost in earlier years.

Balancing risk: The risk that the pensions cannot be indexed with growth in average income, as intended, in the event that the pension system’s liabilities exceed its assets.

Benchmark: A reference index against which the rate of return for the strategic benchmark is compared. The benchmark is used to measure the Fund’s performance.

Buffer fund: The term “buffer fund” means that Fund’s assets will be used to even out temporary fluctuations during periods when pension contributions are not sufficient to cover pension disbursements.

Capital flows: Time series that show how investors are choosing to allocate their capital.

Carry: Gains that are generated by investing at a high rate of interest and borrowing at a low rate.

Compliance: Adherence to a prescribed set of rules.

COSO: Committee of Sponsoring Organizations of the Treadway Commission. COSO is a framework for evaluation of internal control over financial reporting.

Currency exposure: Exposure that arises when an asset is purchased in foreign currency. For example, the purchase of an American share leads to exposure in US dollars. The value of the share, expressed in Swedish kronor, is then affected not only by the share price but also the dollar exchange rate.

Currency hedging: When the Fund purchases assets in foreign currency, this give rise to uncertainty about how the value of the asset will be affected by exchange rate fluctuations relative to Swedish kronor. Currency hedges are used offset this uncertainty.

Discretionary management: Discretionary management can refer to two different things: 1) A limited and specific mandate for an external portfolio manager to make investment decisions on behalf of the client (the Fund) within pre-determined framework. 2) A discretionary investment orientation in which investment decisions are made on the basis of a professional research approach. Unlike quantitative management, this type of management is not rule-based.

Diversification: Investment in a mix of many different asset classes in order to spread risks.

Diversification of risk: All investments, regardless of the type of securities involved (equities, bonds, etc.), are associated with a certain degree of risk. This risk arises from uncertainty about changes in the value of an investment. An important aspect of asset management is therefore the ability to manage this uncertainty, these risks. By investing in many different securities instead up “putting all its eggs in the same basket”, an asset manager can reduce the total risk in its investments without having to forego their expected returns. Första AP-fonden’s asset management is therefore based on diversification of risk in many dimensions: markets/sectors, asset classes, investment strategies, time horizons, asset managers. Among other things, it is this risk diversification that explains why the Fund has allocated a relatively small share of its assets to Swedish investments. The same reasoning lies behind Första AP-fonden’s investments in emerging markets since the Fund’s inception in 2001.

Duration: A measure of interest rate risk. The change in the value of a fixed income security that will result from a 1 %-point change in interest rates.

Emerging markets: Countries included in the MSCI Emerging Markets index, such as several former east bloc countries, South Korea, Taiwan, China, India, Brazil, Mexico and South Africa.

Excess return: The difference in absolute return between a portfolio and its benchmark. See also “active return”.

Expense ratio: Percentage of fund assets paid for operating expenses. Calculated both including and excluding commission costs.

Financial risks: Financial risks arise due to uncertainties associated with the future value of the portfolio. These consist of fluctuations in asset values as a result of changes in market prices, known as market risk, and how well the Fund’s counterparties meet their obligations, termed counterparty risk.

Fundamental research: Analysis of economic indicators at the macro, micro and corporate levels.

ILO’s “Core Labour Standards”: Conventions that regulate basic human rights in the workplace.

Index management: Management of a portfolio where the objective is to mirror a selected index as closely as possible. No active positions are taken, which means that active risk is zero. Synonymous with passive management, opposite of active management.

Index-linked bond: A bond that guarantees a known real rate of return if held until maturity.

Information ratio (IR): A risk-adjusted measurement of fund performance. The information ratio is equal to the active return of a portfolio divided by its tracking error.

Macroeconomic momentum: Time series that indicate whether an economy is in an upward or downward trend.

Market exposure: Distribution of the Fund’s assets in different markets, for example between equities and fixed income investments, between Swedish and foreign asset, etc.

MSCI index: Morgan Stanley Capital International, an international equity index.

Net inflow: The net of incoming pension contributions minus pension disbursements, administrative costs for the pension system and transfers from Första AP-fonden’s Liquidation Fund and the Fourth AP Fund’s (AP4) Special Management Fund.

Nominal return: The rate of return on an investment without adjustment for inflation or other external factors.

OECD Code of Conduct: The OECD Code of Conduct regulates relations between employers, employees and other stakeholders in multinational enterprises in the OECD area.

Operating risks: Operating risks are the risks of losses arising as a consequence of human factors, inadequate systems, inefficient routines and instructions and insufficient control.

Overweight: Overweight is measured in relation to the asset weighting in the strategic benchmark. If the Fund is overweighted in the equities asset class, this means that the Fund has a higher share of equities in its portfolio than in the strategic benchmark.

Passive management: Management of a portfolio where the objective is not to deviate from a specific benchmark.

Private equity: Unlisted shares, i.e. shares that are not traded on any stock exchange. According to the investment rules, the Fund’s portfolio may contain no more than 5% unlisted securities. However, the Fund may not invest directly in unlisted shares but only via holdings in venture capital companies or mutual funds.

Quantitative analysis: Analysis of the foreign exchange, equity and bond markets by means of mathematical modeling.

Quantitative management: A management approach that is largely automated and where investment decisions are based on signals from various quantitative analyses.

Real return: The nominal return realized on an investment adjusted for inflation and other external effects. This method is based on an amount that expresses a constant level of purchasing power over time.

Risk sentiment: Indication of investor risk appetite or aversion – are investors willing to take on risk or do they seek to avoid risk.

Risk-adjusted return: A measure of how much an investment returned in relation to the amount of risk it took on. See information ratio.

rTE: Realized tracking error, i.e. active risk.

Sharpe ratio: A measure that can be considered an indication of the reward-to-risk efficiency of an investment. The ratio is calculated by subtracting the risk-free rate from the rate of return for a portfolio and dividing the result by the portfolio’s standard deviation. The risk-free return is assumed to be the same as that for government treasury bills. Should total return fall below the risk-free level, the ratio is negative and cannot be used to assess risk utilization.

SSIA: Swedish Social Insurance Agency.

Strategic benchmark: The long-term asset allocation that is deemed to best correspond to the Fund’s overall objectives. The strategic benchmark is determined by the Fund’s Board of Directors based on the results of ALM studies. The strategic benchmark then functions as the benchmark index against which the Fund’s risk and return profile are compared.

Tracking error (TE): Active risk, i.e. the variation in absolute return, often measured as the standard deviation. Also known as volatility.

Underweight: Underweight is measured in relation to the asset weighting in the strategic benchmark. If the Fund is underweighted in the equities asset class, this means that the Fund has a lower share of equities in its portfolio than in the strategic benchmark.

VaR: Value at Risk, a risk metric used to estimate with 95% probability the likelihood that a given portfolio’s losses will exceed a certain amount. By adjusting the portfolio composition, VaR can be maintained at a suitable level.

Yield curve exposure: Curve exposure is a strategy used in bond management where the goal is to take active positions with regard to duration (maturity structure).