Beta is a measure of the correlation that a stock or portfolio has to the voaltility of the overall market, often represented by an index. A beta of less than zero indicates that the asset tends to move opposite the market. A beta of zero indicates that the asset’s movment is generally uncorrelated to that of the market. A beta between zero and one indicates that hte asset moves in the same direction as the market, to a lesser degree. A beta of one indicates an asset moves in the same direction, and to the same degree, as the market. And finally, a beta of greater than one indicates an asset moves in the same direction, but to a greater degree, than the market.
Beta is a measure of the correlation that a stock or portfolio has to the overall movement of the market. In other words, it is something you don’t want to have a lot of today.
Generally, a portfolio that moves exactly as much a the overall market has a beta of 1. Something with no correlation to the market has a beta of zero. Something with a negative beta moves in the opposite direction to the market. Something with a beta greater than 1 moves in the same direction, but farther…. For example, a leveraged S&P portfolio.
Q: So, it’s the same as correlation?
Not exactly. For example, if a stock is always up 20% when the market is up 10%, there is a correlation of one, because they always move together. But the Beta is 2, because the stock is up twice as much as the index.
As a result, most people say that lower-beta stocks offer less risk than the overall market; and that higher-beta stocks offer more. Days like this, again, you’re really loving your low-beta stocks. But on days like last Friday, you want higher-beta stocks.
Q. OK, got it. What else about it is important for investors to understand?
Well, because its not something you want to pay for. Investment managers with great track records can be very impressive, but if all they’re doing is giving you “beta” then you could be getting the same returns with a low cost index fund or ETF. In fact, when you hear good hedge fund managers talk, they always use the term disparagingly: I was on the dias at a hedge fund conference lately, and the manager next to me looked out over the crowd and whispered: “man, there’s a lot of beta out there”.
There are definitely things out there that are worth paying for: alpha, non-correlation, true diversification; but beta isn’t one of them.