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Beta, the second Greek letter, is used by investors to mean the volatility of any stock, mutual or hedge fund, or portfolio relative to its market. Beta, like alpha, is a risk-adjusted measure relative or benchmark. Like alpha, beta has origins in CAPM and Modern Portfolio Theory where the market return of a portfolio is compared to a “risk free” market rate or benchmark. Arbitrage Pricing Theory (APT), which uses multiple betas, models a corresponding beta for each APT market risk factor. Statistical software packages are available to calculate beta, and investment advisers sometimes keep a beta book where they can look up the beta of an individual stock, sector, mutual fund or market index and compare it to the beta of a stock market index for the same period. A beta of 1.0 means a stock’s risk is the same as the S&P 500 Index, a beta of 2.0 means a stock’s risk is above the market’s. Remember: risk and return are a trade-off and low beta stocks may produce a low return as well as lower risk. |
