Jargon Buster - V

There are two, quite separate, meanings for this word in terms of investment.

The valuation of a company share means whether it is cheap or expensive, according to various different measures that investment managers use including some you might be familiar with such as P/E ratio and “dividend yield”, as well as other more complicated measures. Obviously, investment managers will prefer to buy the shares of companies whose valuation is cheap, all other things being equal, and will tend to avoid buying the shares of companies whose valuation is expensive.

But ‘valuation’ also means the statement that an investment manager will send to the trustees of a pension fund every month, every three months or every year, giving a list of the investments that have been bought for the fund, and how much those investments are worth at the time that the valuation is drawn up.

This term is most often used, in terms of an investment, to describe a particular style or method of investing. In recent years, a significant number of investment managers have described themselves, or have been described, as ‘value managers’. This means that they tend to be biased towards buying shares which can be described as ‘cheap’, using various technical measures of value as a guide. This is because they believe the share prices of these companies will rise by more than other companies. These investment managers would not have all of their investments in ‘value’ companies, but they would have more than other investment managers.

This strategy at first sight seems too obvious to be true. After all, who would want to buy shares that were not cheap? But it does have drawbacks. Sometimes shares are cheap because:

• the management of the company is very poor;
• the business is operating in a sector where it’s very difficult to see much potential for future growth; or
• there are question marks about the company’s accounting policies.

There can be very good reasons for the shares to be cheap, and perhaps the shares might fall even more and get even cheaper! Nonetheless it is an investment strategy which can work well, particularly at certain times during the economic cycle.

This is an investment fund which invests in a number of businesses which are small, and which are not (yet) quoted on any stock exchange. Many start-up companies can have excellent business ideas, but they need funds to get the business up and running, firstly, and then to expand it later. If you ‘get in on the ground floor’, in terms of investing at an early stage, these companies can be very profitable and they can be very good investments. But while investment managers have the funds to invest in these businesses, they rarely, if ever, have either the skills or the time to work with these small companies and make a success of them. And of course the risks of investing in these very small companies are far larger than the risk of investing in large, blue-chip companies, as quite a few start-up companies may well end up going bust.

The way around this has been to set up ‘venture capital funds’, which invest in a number of these small companies, using funds given to them by the large investment managers. The managers of these funds will generally have a lot of experience in assessing the prospects for small companies with (potentially) good ideas, and will also be able to work with the companies, advising them on the best strategy they can follow for success. They will know that many of the companies that they invest in will fail, but expect that those that do succeed are likely to make them a lot of money!

In a sense, everyone gains. The pension fund and the investment manager invest in potentially a very lucrative set of investments with a reduced risk and as little inconvenience as possible, while the small companies get the cash that they need, as well as expert advice on how to succeed.

This is how far an investment will change price, either upwards and downwards. For example, property tends to change price relatively slowly – and moves in one direction for a long time. As a result, its volatility is said to be fairly low. On the other hand, the price of the shares in ‘dot-com’ companies some years ago tended to move very rapidly – both up and down! So those shares were said to have high volatility. To an extent, you could use the word risk instead of volatility – the meaning is much the same. The more volatile or risky an investment, the more money is likely to be either made or lost.