Course 203: Looking at Historical Risk, Part 1  
Beta  

Beta, meanwhile, is a relative risk measurement, because it depicts a fund's volatility against a benchmark. Morningstar calculates betas for stock funds using the S&P 500 Index as the benchmark. We also calculate betas using what we call a fund's bestfit index, which is the benchmark whose performance most resembles that of the fund. For bond funds, for example, we use the Barclays Capital Aggregate Bond Index and bestfit indexes. Beta is fairly easy to interpret. The higher a fund's beta, the more volatile it has been relative to its benchmark. A beta that is greater than 1.0 means that the fund is more volatile than the benchmark index. A beta of less than 1.0 means that the fund is less volatile than the index. In theory, if the market goes up 10%, a fund with a beta of 1.0 should go up 10%; if the market drops 10%, the fund should drop by an equal amount. A fund with a beta of 1.1 would be expected to gain 11% if the market rises by 10%, while a 10% drop in the market should result in an 11% drop by the fund. Conversely, a fund with a beta of 0.9 should return 9% when the market goes up 10%, but it should lose only 9% when the market drops 10%. The biggest drawback of beta is that it's really only useful when calculated against a relevant benchmark. If a fund is being compared with an inappropriate benchmark, its beta is meaningless. There's another statistic that is often overlooked in this discussion of volatility: Rsquared, which you can find under the Ratings & Risk tab of a fund's report on Morningstar.com. The lower the Rsquared, the less reliable beta is as a measure of the fund's volatility. The closer to 100 the Rsquared is, the more meaningful the beta is. Gold funds, for example, have an average Rsquared of just 0.26 with the S&P 500, indicating that their betas relative to the S&P 500 are pretty useless as risk measures. Unless a fund's Rsquared against the index is 75 or higher, disregard the beta. Next: The Quiz >> 
Search 
Print Lesson
 Feedback Del.icio.us  digg it 
Learn how to invest like a pro with Morningstar’s Investment Workbooks (John Wiley & Sons, 2004, 2005), available at online bookstores.  
© Copyright 2015 Morningstar, Inc. All rights reserved. Please read our Privacy Policy. If you have questions or comments please contact Morningstar. 
