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Beta

Beta is another volatility measure commonly used to compare an asset’s (or strategy’s) volatility to the risk of the broader market (systematic risk). In other words, if a specific asset or a strategy has higher swings (it is more volatile) than its broader market, its beta will be higher than 1.0; and if it moves less than its broader market, it will have a beta below 1.0. Therefore, if an asset has a beta of 1.5, it will theoretically be more volatile than its market, with higher expected returns but with higher intrinsic risks.

An asset’s broader market refers to the stock market which the asset belongs to. Generally, a market’s index is used as a proxy for the broader market (benchmark); for instance, the S&P500 Index can be used as a proxy for the US market, or the STOXX Europe 600 can represent the European market.

The beta coefficient is a statistical measure that represents the slope of the regression line plotted by inputting an asset’s returns against its market’s. It is also a component of the CAPM (Capital Asset Pricing Model), which intends to assess the return investors can expect to receive based on volatility. We will look into regression and the CAPM in future segments.

Many investors use beta to try to quantify how much risk new investments could add to their portfolios.

For now, all you need to know about the Beta measure is the following:

  1. Asset volatility vs its market’s: it measures the volatility of an asset against its market’s systematic volatility
  2. Its value revolves around 1.0:
    • A beta lower than 1.0 = lower risk and lower return than that of the market
    • A beta equal to 1.0 = similar risk and similar return to that of the market
    • A beta higher than 1.0 = higher risk and higher return
  3. 5 year, monthly: you can easily find an asset’s beta online, many sites report data by analyzing an asset’s 5-year monthly performance vs its market’s
  4. Shorter-term volatility measure: many investment professionals argue that beta is more useful for short-term volatility analysis than for long-term investing

We believe it is a good measure to assess an asset’s level of risk, but investment decisions should not be made just based on the beta metric.

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