Rather than something you might get done at the hairdressers, this type of haircut applies to collateralised agreements in the financial markets. In a lending agreement, the lender may subtract a certain percentage from the value of the assets that are being put up as a collateral to reflect the risk associated with holding the assets. This difference between the market value and the assigned value is known as a haircut.
Assets such as US Treasury Bills are perceived to be very safe and at minimal risk of default so if an institution uses these as collateral for a debt agreement, then haircuts are correspondingly small – perhaps only 1 per cent. In contrast, Ireland’s National Asset Management Agency (NAMA) last week announced haircuts of between 35 and 58 per cent on toxic loans submitted to it by Irish banks.
European Central Bank (ECB) President Jean-Claude Trichet said last month that the ECB will in the future have a “graded haircut schedule” when it assesses refinancing costs – currently it determines haircuts on eligible securities by the asset class (based on liquidity), residual maturity, and the coupon type. This fourth criterion is likely to be a focus of the press conference that will follow the ECB’s policy decision on Thursday.
TOTAL EXPENSE RATIO (TER)
The TER is a measure of the total costs associated with managing and operating an investment fund or exchange-traded fund. It provides investors with a clearer picture of the total annual costs involved in running an investment fund.
These costs normally include management fees as well as other costs such as trading fees, legal fees and rebalancing fees. The TER is equal to the total cost of the fund is divided by the fund’s total assets to give a percentage.
Economies of scale are important – a large fund will tend to have a lower TER than a small fund. Funds investing in overseas markets are also typically associated with higher annual costs. But the primary difference between fund’s TERs is the manager’s annual fee.
The TER of a fund is important because the costs affect investors’ returns and it can also amplify tracking error in exchange-traded products.