Ghost (????????????????????????) busters – edition 2
Welcome to the next instalment in the jargon-busting series of articles on The Finance Ghost.
Let’s jump straight in with one term from each world of investments and financial management:
Probably the sexiest term in finance but also one of the least understood, “hedge fund” is synonymous with high-flying investment professionals earning huge money and having movies made about them.
To some extent, that’s pretty accurate, especially in America. Hedge funds are alternative investment structures that give professionals far more flexibility to manage your money. Instead of being restricted to one type of asset (e.g. shares) and one strategy (e.g. Top 40 only), hedge funds usually have wider mandates and the ability to use complicated financial instruments to manage risk.
When markets are turning for the worse, hedge fund managers should be able to protect your capital and even profit off a downturn. An investment manager with a tight mandate of only investing in e.g. South African shares will be able to do very little about a crashing market.
Unfortunately, due to the complexity, hedge funds are usually only available to wealthy investors who can commit significant funds to the investment.
Mix effect is the impact on a financial metric of a change in proportions of the underlying items in that metric.
For example, a retailer may sell a wide variety of products all at different margins. If for any reason the proportion of basic goods increases relative to luxury goods, the gross profit margin will be lower. This would be described as a mix effect.
A great example is Amazon’s recent results over the global lockdown period, where sales growth was excellent but product mix effect resulted in a decrease in gross margin. Selling more basic household goods and fewer luxury TVs doesn’t do your margins any favours.
An alternative explanation for a drop in gross profit could be that price increases aren’t being passed on to consumers fully or that the company’s buying department isn’t performing as well as it should.
You can see that one impact is simply the result of consumer preferences, whereas the others may indicate a more fundamental problem in the company. This is why isolating the true cause of a change in margin is critical when analyzing any company.