Glossary

'40 Act: The 1940 Investment Companies Act, an act of the US Congress that regulates the oversight of investment companies and their product offerings.
AFFE: Acquired fund fees and expenses (AFFEs) are fees charged by BDCs that mutual funds and other registered funds must aggregate with their own fees when reporting expense ratios.
Alpha: The portion of total investment return attributable to manager skill and not market return.
Alternative risk premia: The portion of total investment return attributable to common factors (value, growth, momentum) that are thought to potentially provide long‐term incremental return due to investor behavioral biases.
ASC 820: The generally accepted accounting principal (GAAP) standard that dictates how the fair value of assets is determined, breaking up the process of valuation into three levels. (See also Level 3 Assets.)
Asset weighted: An index or portfolio whose security holdings and returns are weighted by the asset value, as opposed to equal weighting.
Bloomberg Barclays 3–5 Year Treasury Index: A fixed income index comprised of publicly issued US Treasury securities that have a remaining maturity greater than or equal to three years and less than five years.
Base rate: A short‐term, typically floating, interest rate (e.g., Libor, Prime, T‐bill, Fed Funds) which, in addition to a constant spread to compensate for credit risk, determines the amount of interest periodically paid to the lender by the borrower; also called the reference rate.
BDCs: '40 Act investment vehicles called business development corporations that invest in securities, mostly loans, to middle market US companies.
Benchmark return: The return of an index, known as the benchmark index, that serves as a comparative measure to assess portfolio composition and gauge relative performance.
Benchmark risk: The degree to which the return of a portfolio deviates from that of its benchmark; also known as tracking error.
Beta: The measure of an asset's price volatility relative to a market index. For example, a security with an equity beta measured at 0.80 moves up or down 0.80 multiplied by the market index return.
Black–Cox model: A formulation for valuing covenants using option‐pricing theory.
Black–Scholes model: A formulation for valuing security options based on price, exercise price, the risk‐free interest rate, and time to expiration.
Bloomberg Barclays High Yield Bond Index: A commonly used index of publicly traded non‐investment‐grade, or junk, bonds. Source: Bloomberg Barclays Index Services Limited.
Broadly syndicated loans (BSLs): Larger secured and unsecured corporate loans originated by banks and nonbank lenders, with smaller shares then sold (syndicated) to other investors (see also leveraged loans).
Broker quote: A price representing what a broker would pay for a specified security at a point in time. Used to value broadly syndicated loans that trade among broker dealers.
C&I loans: Commercial and industrial loans are a commercial bank classification for loans made primarily to the bank's corporate borrowers.
Cambridge US Private Equity Index: An index based on financial information of US private equity funds. Source: Cambridge Associates LLC; data provided “as is” and at no cost to Cliffwater LLC.
Capital International Index: The earliest index of non‐US stock performance that is now Morgan Stanley Capital International.
CAPM: The capital asset pricing model, a framework developed by Nobel Laureate William Sharpe for separating the idiosyncratic (diversifiable) and systematic (undiversifiable) risk of an asset and how exposure to these risks affect expected returns.
CDLI: The Cliffwater Direct Lending Index, an asset‐weighted index of direct US middle market loans originated by private and public BDCs.
Collateralized loan obligation (CLO): A structured investment vehicle comprised of loans and other fixed income securities. CLO cash flows are pooled into tranches and packaged as securities, with a separate credit rating for each, and sold to investors. The most junior security, which is last in receiving coupon and principal payments, is referred to as CLO equity. The purpose of the CLO is to allow loan originators to offload their exposure to these loans, and also to obtain a lower cost of capital for making new loans.
Common factor risk: Risks related to pre‐specified systematic (no‐diversifiable) factors, such as price momentum, carry, and earnings quality, that are expected to generate above‐market returns under certain conditions. Certain investment strategies, such as risk premia, rely on quantitative models to identify and assign weightings to common factor risks.
Convexity: The degree to which asset returns are affected by the change in, as opposed to the level of, a systematic risk factor, such as beta or duration. For example, assets with positive convexity to equity beta will perform better during down markets, as their convexity offsets the negative impact on returns of equity beta.
Correlation: The degree to which the prices of assets move in relation to each other. Portfolio diversification is improved when adding assets with a low correlation to a legacy portfolio.
Cost value: The initial amount paid for an asset, which is compared with the fair value of the asset to measure its realized or unrealized gain or loss.
Covenant: Part of a loan or bond issue requiring the borrower to fulfill certain conditions on an ongoing basis. A covenant violation can lead to the lender declaring the borrower to be in default of their loan. Covenants may include taking on additional debt or maintaining a certain level of interest coverage.
Covenant lite: A loan agreement or bond issue with a relatively small number of covenants, or where covenants are less stringent. These make it easier for a borrower to avoid default.
Credit premium: The additional yield of a fixed income security to compensate the lender or investor for credit risk. Higher credit risk leads to a higher credit premium.
Credit rating agency: A firm that assigns credit ratings to securities, enabling investors to assess their credit risk; the big three rating agencies are S&P Global, Moody's, and Fitch Group.
Credit risk: The probability of a borrower defaulting on their loan.
CRSP: The Center for Research in Security Prices, part of the University of Chicago Booth School of Business, was launched in 1960 to provide objective, accurate, and comprehensive data on listed stocks.
Current Yield: The annual coupon payments of a bond or loan divided by its current price.
Default: The failure of a borrower to make scheduled coupon and/or principal payments. When a borrower defaults, the lender(s) have certain remedies, including foreclosure on collateral used to back the loan.
Dispersion: The spread of returns or prices within a group of securities or portfolios. For example, a higher dispersion of prices among related securities, or wider spread between the high and low observations, can indicate the market is less efficient, providing more opportunity to generate alpha.
Dodd–Frank Act: The Dodd–Frank Wall Street Reform and Consumer Protection Act was signed into law by President Obama in 2010, created new, and amended existing, regulations to improve the stability of the US financial system and protect consumers against abusive lending practices. The law was a consequence of the 2008–2009 global financial crisis.
Down‐and‐in option: A type of option that becomes active when the price of an underlying security falls below a certain level, called the barrier price; once this occurs the option behaves like a normal put or call option.
Duration: A measure of how changes in interest rates inversely affect the price of an asset. For example, an asset with a five‐year duration would decrease in price by 5% with a 1% increase in interest rates.
EBITDA: Earnings before interest, taxes, depreciation, and amortization; an adjusted measure of the net income of a business that allows better comparability across companies.
Effective life: A measure of how long a depreciating asset will generate cash flow.
Effectively connected income: Income generated in the United States by commercial or investment activity of a foreign person or business.
Equity: The residual value of a company after deducting debt and other liabilities; investors purchase equity in a company through common or preferred stock.
Euribor: The Euro Interbank Offered Rate is a daily reference rate based on several money market rates at which Eurozone banks lend to one another for uncollateralized loans (see also Libor).
Euro crisis or Eurozone crisis: The European debt crisis, which effectively began in 2009 and has continued to the present day, refers to the inability of certain members of the Eurozone to maintain the total debt of their countries within the initial guidelines set when the Euro was originally created; this affects the perceived creditworthiness of their sovereign debt. The adoption of a single currency creates less flexibility for member countries in refinancing debt.
Fair value: An estimate of the market value of an asset, typically provided by an auditor during the appraisal process.
Fair value accounting: An accounting industry approach to establish an estimate of the market value of an asset, using independently observable inputs in lieu of a market transaction.
Fiduciary: A person or legal entity holding assets, or making business or investment decisions, as an agent‐in‐trust on behalf of a principal, such as a stockholder or trust beneficiary.
First‐out loan: The senior component of a unitranche loan where first‐out lenders, in exchange for a lower coupon rate, are the first to receive interest payments and have a more senior repayment position if the loan is paid off or refinanced, as opposed to last‐out loans.
Floating rate: Loans whereby the coupon payment is not fixed but is adjusted with the level of a reference rate, such as US T‐bills or Libor.
Global financial crisis (GFC) (2007–2009): A reference to the period 2007–2009, generally considered the worst global financial crisis since the Great Depression in the 1930s. The GFC was sparked by aggressive mortgage lending practices, which enabled unqualified borrowers to obtain mortgage loans on which they subsequently defaulted. Exposure to these loans spread throughout the global financial system through structured securities, worsened by excessive leverage taken by banks and other financial institutions. These dislocations led to failures and government bailouts of many banks and investment firms worldwide, including most notably Lehman Brothers in September 2008.
Gordon Model, or Gordon Growth Model: A method of estimating the intrinsic value of a security, whereby the value of the security equals the present value of future dividends, measured by the sum of current cash yield plus cash flow growth. Also known as the dividend discount model (DDM).
Illiquidity premium: The incremental return of an asset resulting from it being priced and traded infrequently, compared with a more liquid asset having otherwise similar characteristics; it represents the return required by an investor to hold an illiquid asset.
Impairment: A permanent reduction in the fair value of a loan to below its cost basis, due to the increased probability that the interest and/or principal of a loan will not be repaid.
Income return: The portion of an asset's total return from interest or dividend income, rather than capital gains.
Incurrence covenant: Part of a loan agreement or bond issue whereby the borrower is not allowed to take certain affirmative actions, such as incurring additional debt, an additional dividend payment or share repurchase, or acquiring or divesting a business (see also maintenance covenant).
Intercept: The constant in a model regression, or the number that results if the variable equals zero.
IPO: Initial public offering, whereby a company or subsidiary is first listed on a stock exchange.
J‐curve: The initial period of a private investment whereby returns are low or negative due to the payment of management fees and expenses, before investment gains are captured. Being “out of the J‐curve” means investment gains more than offset cumulative fees and expenses.
Junk bonds: Bonds rated below investment grade; also known as high‐yield bonds.
Last‐out loan: The junior component of a unitranche loan where last‐out lenders, in exchange for a higher coupon rate, are the last to receive interest payments and have a more junior repayment position if the loan is paid off or refinanced (as opposed to first‐out loans).
Level 3 assets: Assets whose fair value cannot be determined using broker quotations or observable inputs or measures; this is part of an accounting classification system used for valuing assets introduced by FASB 157 as ASC 820.
Leverage: Obtaining debt to increase investment capital for purchasing assets or originating loans.
Leveraged buyout: The acquisition of another company using a high level of debt financing.
Leveraged loans: Secured and unsecured loans originated by banks or nonbank lenders that are then syndicated to a group of investors; also known as broadly syndicated loans.
Libor: London Interbank Offered Rate, a widely used reference rate set daily among the main UK banks, at which banks around the world lend to one another for uncollateralized loans.
Liquidity premium: The incremental value of an asset resulting from it being priced and traded frequently, compared with an illiquid asset having otherwise similar characteristics. For example, public companies generally trade at higher price‐to‐earnings multiples than similar private companies.
Loan‐to‐value ratio: The amount of aggregate debt compared with the total value of an asset, including equity and debt, typically used in the real estate industry. It is frequently cited as a measure of financial leverage and risk.
Log scale: A logarithmic scale is a nonlinear scale, typically used when the y‐axis represents a percent change or multiplicative factor, such as a compounded rate of return.
Lower middle market: Typically represents companies with annual EBITDA of less than $25 million.
Maintenance covenants: Part of a loan agreement or bond issue whereby the borrower must maintain certain financial tests, such as net interest coverage or profitability (see also incurrence covenant).
Marginal yield: The change in yield relating to increased leverage, used to measure the relationship between increased leverage and higher borrowing costs.
Maximum drawdown: The maximum historical drop in the market value of an asset or portfolio from peak to trough.
Mean–variance analysis: An analytical framework first posited by Nobel Laureate Harry Markowitz that compares the expected risk of an asset or portfolio, typically measured by the standard deviation of returns, with its expected return.
Merton Model: A model proposed by Robert Merton that uses an options pricing model to value a company's equity, with equity as a call option on its assets.
Mezzanine: The layer of a company's financing, or capital structure, that falls between senior secured and asset backed debt and equity. Mezzanine financing often covers multiple capital structure segments, including subordinated debt, and may include equity warrants. Source: PitchBook, private capital market data provider.
Middle market direct loans: Loans originated by banks or nonbank lenders directly to middle market corporate borrowers (defined as having annual EBITDA between $10 million and $100 million). These loans are typically bilateral (not broadly syndicated) or may be syndicated to a small group of lenders. The companies may be sponsor‐backed (controlled by a private equity firm) or nonsponsored (often family‐owned businesses).
MLP: Master limited partnerships, publicly traded limited partnerships that combine the tax advantages of private limited partnerships, with profits taxed only after distributions are made to investors, with the liquidity of publicly traded equity. MLPs are most commonly used in the oil and gas sector.
NCREIF: National Council of Real Estate Investment Fiduciaries, an industry association serving real estate investors in the United States that seeks to collect, aggregate, and disseminate real estate industry data.
NCREIF Property Index (NPI): A market‐value‐weighted index sponsored by the National Council of Real Estate Investment Fiduciaries (NCREIF) that is comprised of commercial real estate properties in the US, used to measure the performance of private real estate funds. Returns are reported on an unlevered basis.
Net annualized returns: Annual returns from an investment inclusive of market value gains and losses, and net of all fees and expenses.
Net asset value: The market value of a fund's assets minus its liabilities, divided by the number of shares outstanding.
Non‐investment‐grade loans: Loans rated below investment grade by one or more of the major credit rating agencies. Direct loans are typically non‐investment grade.
Nonsponsored borrower: A company borrowing from a direct lender that is not controlled by a private equity firms or investor.
Oil crisis (2015–2016): The period when oil and natural gas prices fell precipitously due to a rapid increase in production by the United States, paired with decreased demand from China and a refusal by OPEC to slow production. This led to distress among energy producers refinancing outstanding debt.
Original issue discount: A form of loan origination fee, typically 2–4% of the loan balance, structured so that the loan amount received by the borrower is slightly less than the par value of the loan.
Origination: The sourcing and structuring of a loan.
Pari passu: A financing arrangement that gives multiple lenders equal claim to assets used to secure a loan.
PIK income or payment‐in‐kind: A bond interest payment in the form of additional securities of the same bond issue rather than cash.
Prepayment: The settlement of bonds or loans before maturity; bond issues often have terms or penalties limiting prepayment to mitigate reinvestment risk for the lender.
Prepayment penalties: Fees charged to the borrower for settling a loan or bond before maturity.
Principal: The notional amount of a bond or loan, representing the amount borrowed, upon which coupon payments are calculated.
Private equity: The ownership and/or control of companies that are not listed on public exchanges; it can also represent private partnerships formed for raising investment capital.
Random walk: Refers to price changes that do not follow a discernable pattern or trend.
Realized gains: The profit resulting from selling an asset at a higher price than its cost basis.
Recovery: The collection of a portion of the remaining amount due on a defaulted loan.
Reference rate: A short‐term, typically floating, interest rate (e.g., Libor, Prime, T‐bill, Fed Funds) which, in addition to a constant spread to compensate for credit risk, determines the amount of interest periodically paid to the lender by the borrower.
Reinsurance: Insurance purchased by insurance companies to reduce the risk of catastrophic events.
REIT: Real estate investment trust, a type of regulated investment company (RIC) that owns real estate assets and is required to pass through at least 90% of related income to the shareholders.
Revolver: A secured credit line, typically provided by a commercial bank, for a company's short‐term funding needs; revolvers are senior in the capital structure to other debt and equity; it is also called a revolving credit facility.
RIC: Regulated investment company, a legal entity regulated by the SEC that is publicly traded, like common or preferred stock. RICs are required to pass through at least 90% of capital gains, dividends, or net interest earned to maintain their tax‐exempt status.
Risk premium: A yield or return in excess of the risk‐free rate, compensating the lender or investor for the various sources of risk relating to the investment.
Risk‐off: A capital shift by investors to limit or reduce exposure to riskier investments in favor of those perceived as being less risky.
R‐squared: A statistical measure representing the proportion of variance for a dependent variable explained by an independent variable; a higher R‐squared suggests a stronger relationship between two variables and a more powerful regression model.
Rule 17d: The rule prohibits first‐ and second‐tier affiliates of a fund acting as principal or engaging in a joint‐arrangement with the fund; what this means in practice for direct lending is that investment managers cannot allocate participation interests in loans they buy or originate to both private and registered funds without a 17d exemptive order.
Russell 3000: A market capitalization weighted index maintained by FTSE Russell designed to represent the broad investible US equity universe. It includes approximately the 3,000 largest stocks listed in the United States. (The Index is calculated by or on behalf of FTSE International Limited or its affiliate, agent or partner. The LSE Group does not accept any liability whatsoever to any person arising out of the use of, reliance on or any error in the Index. The LSE Group makes no claim, prediction, warranty or representation as to the suitability of the Index for the purpose to which it is being put.)
Russell 2000: A small‐cap stock market index including approximately the 2,000 smallest stocks in the Russell 3000 Index. (The Index is calculated by or on behalf of FTSE International Limited or its affiliate, agent or partner. The LSE Group does not accept any liability whatsoever to any person arising out of the use of, reliance on or any error in the Index. The LSE Group makes no claim, prediction, warranty or representation as to the suitability of the Index for the purpose to which it is being put.)
S&P/LSTA Leveraged Loan Index: An index designed to reflect the performance of the largest facilities in the leveraged loan market.
Senior debt, or senior secured debt: A priority claim over subordinated debt, mezzanine, and equity in a company's capital structure, typically secured with collateral such as property, plant and equipment, and receivables.
Senior first lien: A senior secured claim to second‐lien and other subordinated and junior debt, mezzanine, and equity, in a company's capital structure, and is typically junior only to bank revolvers, accounts payable, and other short‐term secured financing.
Senior second lien: A junior secured claim to first‐lien debt in a company's capital structure, which is senior to subordinated debt, mezzanine, and equity.
Serial correlation: The degree to which the value of a variable at a given time (t) is related to its value in the immediately preceding period (t – 1), measured over various time periods.
Shadow rating: An unofficial credit rating given by a credit rating agency to a bond that is not publicly announced.
Short volatility: An investment strategy designed to profit from a decrease in market volatility.
Skew: A measure of the asymmetry of a probability distribution.
Smoothing of asset values: When the fair values of assets don't change significantly over time due to their being appraisal‐based rather than marked to market.
Sponsored borrower: A company borrowing from a direct lender that is controlled by a private equity firm or investor; the direct lender typically works directly with the private equity sponsor to negotiate the size and terms of the loan.
Standard deviation: A measure of risk or volatility of an asset's prices and returns, it is the degree to which individual observations within a statistical set vary from their mean.
Stretch senior: A type of hybrid loan structure that combines senior debt and junior debt: the senior debt stretches to include junior parts of the capital structure.
Subordinated debt: Typically, unsecured debt that is junior to more senior secured debt; subordinated claims are paid out only after senior claims are satisfied.
Syndicate: A group of investors and lenders that contribute capital to participate in a loan; syndicate members acquire their loan interests from the loan originator or underwriter.
Tracking error: The degree to which the return of a portfolio deviates from that of its benchmark; also known as benchmark risk.
Unitranche loan: A flexible hybrid loan that combines senior secured debt and subordinated debt at a single blended interest rate.
Unrealized gains: The profit on an investment that remains unsold.
Unrelated business taxable income: Income generated by a tax‐exempt entity for investment and business activities outside the main function of the entity.
Unsmoothing: A technique to more accurately reflect the degree to which an appraised asset's fair value changes over time based on market conditions.
Upper middle market: Typically represents companies with annual EBITDA of more than $75 million.
Valuation agent: An agent or entity responsible for determining the value of an asset.
Variance: The square of the standard deviation.
Vintage weighting: A measure of business cycle diversification of an investment portfolio.
Vintage year: The year in which capital is first called for a private partnership.
VIX: Shorthand for an index created by the Chicago Board Options Exchange that measures the stock market's expected volatility based on the pricing of S&P 500 Index options; formally known as the CBOE Volatility Index.
Warrants: A derivative security that entitles the holder to purchase an underlying security at a fixed price up to an expiry date.
Yield: Interest income plus fee income, divided by fair value.
Yield‐to‐three‐year‐takeout: The equivalent of yield to maturity for a loan, reflecting that middle market corporate loans are typically refinanced within about three years, rather than their five‐year stated maturity.
Yield‐to‐Maturity: The estimated rate of return based on the assumption that it will be held until its maturity date and not prepaid or called.