Absolute return
The actual return, in kronor or percentage terms, generated by a portfolio during a specific period.

Absolute risk
The variation in absolute returns. Also known as volatility and is calculated as standard deviation.

Active management
Form of management based on taking active positions in order to achieve higher returns than the benchmark index. Active positions are taken by being overweight or underweight in assets relative to the benchmark index or reference portfolio based on market forecasts.

Active return
Difference between the return on a portfolio and its benchmark index.

Active risk
The variation in active return. Also known as tracking error.

ALM analysis
Asset liability modelling. Is performed using statistical simulations of how portfolios with different asset mixes enable AP3 to meet its pension system commitments. ALM analysis forms the basis for the choice of assets for strategic portfolio asset selection.

Alpha returns
Returns that are higher than beta and achieved by taking active positions. (See Beta)

Automatic balancing
Occurs when pension system liabilities exceed assets. Balancing involves indexing pensions at a lower rate until the system regains equilibrium.

Balance ratio
Total pension system assets (excluding premium pensions) divided by liabilities. If the balance ratio drops below 1, the automatic balancing mechanism is activated (see definition). This affects pension indexing.

Benchmark index
Used to evaluate the return on a portfolio. Usually takes the form of a standardised market index and is also known as the reference index.

Beta
Sensitivity of a portfolio or equity to equity market movements. A share with a beta value of > 1 is expected to outperform a rising market. A share with a beta value of < 1 is expected to underperform a falling market, and a share with a beta value of =1 is expected to perform in line with the market. Beta can also be expressed as the return generated by passive exposure to risks such as equity risk, credit risk and volatility.

Buffer fund/buffer capital
Name for the First, Second, Third, Fourth and Sixth Swedish National Pension Funds. The role of the buffer funds is to even out temporary variations between pension contributions and disbursements and to assist in the long-term financing of the pension system.

Buyout
Acquisition by an entity of a controlling interest in a mature company.

CDM (Clean Development Mechanism)
An arrangement under the Kyoto Protocol allowing industrialised countries with a greenhouse gas reduction commitment to invest in ventures that reduce emissions in developing countries as an alternative to more expensive emission reductions in their own countries.

Cleantech
Short for clean technology and refers to energy- and environment-related technologies developed to reduce adverse environmental impacts.

Clearing
All activities that take place after a transaction is completed in a market place and prior to settlement. Includes reporting, risk measurement and netting.

Clearing house
An institution with regulatory approval to conduct clearing operations. Most countries have only one or a very few. In Sweden, clearing is via the Stockholm Stock Exchange. The exchange acts as counterparty for all derivatives traded via its system.

CLS
Bank owned by currency market counterparties and used in most currency transactions for effective settlement.

Code of conduct
A corporate code of conduct is a group-wide framework of rules and systems to handle environmental and social concerns.

Corporate governance
Describes how companies are run and managed. The relationship between the different company organs (AGM, board and CEO) is at the heart of corporate governance.

Credit bond
Fixed income security with a higher level of risk than government bonds. Often issued by corporations and mortgage lending institutions.

Credit swap
Derivative contract between two parties, A and B, in which A pays B an interest premium for a specific period of time. B only pays a premium to A in the event that a predetermined asset related event occurs. The size of this premium is the difference between the nominal underlying value of the derivative contract and the market value of the asset in question (credit default swap).

CSA agreement
Annex to the ISDA agreement that regulates how an entity with an outstanding debt (unrealised loss) must provide collateral in the form of cash or securities.

Derivatives
Financial instruments whose price is determined by underlying securities. Options, forwards and swaps are generally classed as derivatives. A derivative’s value depends on changes in the value of the underlying asset.

Duration
Used as a measure of interest rate risk by estimating the percentage change in the value of a bond in the event of a change of 1 percentage point in market interest rates.

FSC (Forest Stewardship Council)
An international certification system for sustainable forestry.

Fund strength
Measurement of for how many years the buffer funds can meet Sweden’s pension needs in the absence of any inflow of pension contributions.

Fundamentally based indexes
Are indices in which stocks are weighted by a fundamental factor or factors other than capitalization which is used for most other indices.

Hedging
Neutralisation of currency risk, i.e. the risk of investing in currencies other than SEK.

High yield
Bonds with a higher credit risk than government bonds and that therefore offer higher returns. They usually have a lower credit rating than investment grade bonds.

Index management
See Passive management.

Information ratio
Efficiency measurement for active management. It indicates how much AP3 earns from active risk-taking and from deviating from the strategic portfolio or index. Measured as active return divided by active risk (tracking error).

Investment grade
Bonds which have a credit rating of BBB or higher. Generally associated with low credit risk.

ISDA agreement
Bilateral agreement between two OTC counterparties that regulates the events that could generally be expected to occur between them.

LEED (Leadership in Energy and Environmental Design)
Environment certification system for buildings. Includes assessment of use of energy, in-door climate, use of and recycling of locally produced materials and innovative design.

Mezzanine loan
Type of subordinated loan that can be a combination of credit and share options which give the lender a return comparable to return on equity. Mezzanine loans have a higher rate of interest than bank loans to compensate for a higher level of risk resulting from the fact that bank loans have a more senior repayment obligation.

Normal portfolio
The portfolio AP3 would choose if all assets were correctly valued, ignoring asset price movements of a medium-term nature and those driven by economic factors. It reflects the Fund’s long term asset mix.

OTC (Over-the-counter)
Contracts agreed and settled between two counterparties without the involvement of a clearing house.

Overlay mandate
A mandate that ties up little or no capital and is outside the reference portfolio.

Passive management
Asset management that aims to achieve an identical return to the benchmark index rather than to beat the index. This is done through investment that mirrors a reference portfolio or index and is also known as index management.

Private equity
Collective term for equities that are not listed on an official or public market.

Rating
Measure of credit worthiness that denotes the probability that a counterparty can fulfil its commitments. The rating can relate to the counterparty itself or a series of securities issued by the counterparty.

Real return
Nominal return adjusted for inflation.

Rebalancing
The action of bringing the weights in a portfolio of investments that has deviated away from one’s target asset allocation back into line.

Reference portfolio
See Strategic portfolio.

Reference index
See Benchmark index.

Risk-adjusted return
Means of evaluating management performance in which active return is considered in relation to the level of risk in the portfolio. The Sharpe and information ratios are examples.

Risk budgeting
Adjustment of risk levels across management mandates based on their expected return and correlation to optimise the total risk-adjusted return.

Risk capital
Generally refers to investments in a company’s equity. In practice, it relates to investments in companies that are not listed, i.e. private equity.

Sector allocation/sector strategy
That part of the investment process that focuses on being overweight or underweight in different sectors of the equity market relative to a reference portfolio or index with the aim of outperforming the reference portfolio or index.

Semi-fixed weights
In a portfolio, these are weights that are permitted to vary within specific limits. They reduce the transaction costs that arise from rebalancing of the portfolio due to market movements.

Semi-passive index management
Management style that often has a quantitative orientation and that attempts to outperform the index with only a small level of active risk. Also known as enhanced index management.

Sharpe ratio
Measurement of a portfolio’s risk-adjusted return, i.e. the efficiency of the portfolio. Equates to portfolio return minus risk-free interest divided by the standard deviation of portfolio return.

Strategic portfolio
Also called the reference portfolio. Based on AP3’s analysis, it is the allocation of asset classes best suited to the Fund’s pension system commitments over a timeframe of one to three years.

Sustainability reporting
The way a company reports its activities and impacts relating to financial, environmental and social issues.

Tactical asset allocation
Overweights or underweights in different asset categories rather than individual securities in order to generate outperformance.

Tracking error
Measures the variation in active return and is measured as the standard deviation of active return. Historic (ex post) tracking error describes the variation in realised active return and thus measures risk levels retroactively. Expected (ex ante) tracking error is a forecast.

Value at Risk (VaR)
Common measurement of the maximum loss that a portfolio can sustain under a certain period of time and with a certain level of confidence. VaR is calculated daily for a period of one day and a confidence level of 95%. Portfolio management often requires changes to the structure of the portfolio to keep this risk of loss at an acceptable level.

Venture capital
Investments made at an early stage in a company’s development. The capital injected is often used to fund product or market development.

Volatility
A measure of the variation in return. Measured as the standard deviation of return.

Yield curve
Curve showing the relationship between market interest rates and maturities (or duration) of bonds with the same type of issuer and credit risk.