Documenti di Didattica
Documenti di Professioni
Documenti di Cultura
Calculating 'Beta'
Beta is calculated using regression analysis. Beta represents the tendency of a
security's returns to respond to swings in the market. A security's beta is calculated
by dividing the covariance the security's returns and the benchmark's returns by the
variance of the benchmark's returns over a specified period.
Using Beta
A security's beta should only be used when a security has a high R-squared value in
relation to the benchmark. The R-squared measures the percentage of a security's
historical price movements that could be explained by movements in a benchmark
index. For example, a gold exchange-traded fund (ETF), such as the SPDR Gold
Shares, is tied to the performance of gold bullion. Consequently, a gold ETF would
have a low beta and R-squared in relation to a benchmark equity index, such as the
Standard & Poor's (S&P) 500 Index. When using beta to determine the degree of
systematic risk, a security with a high R-squared value, in relation to its benchmark,
would increase the accuracy of the beta measurement.
Beta is just one useful metric for evaluating a stock's trading tendencies. Here is a
list of the top and bottom 3 Beta stocks in the S&P 500. The list updates daily, so add
stocks to your Watchlist so you can check on their performance, financial metrics
and fundamental indicators.
FCX
Freeport-McMoRan Inc
CHK
Chesapeake Energy Corp
WMB
Williams Companies Inc
Lowest Beta Stocks in the S&P 500
Add Symbol
FTI
TechnipFMC PLC
FTV
Fortive Corp
ED
Consolidated Edison Inc
Interpreting Beta
A beta of 1 indicates that the security's price moves with the market. A beta of less
than 1 means that the security is theoretically less volatile than the market. A beta of
greater than 1 indicates that the security's price is theoretically more volatile than the
market. For example, if a stock's beta is 1.2, it's theoretically 20% more volatile than
the market. Conversely, if an ETF's beta is 0.65, it is theoretically 35% less volatile
than the market. Therefore, the fund's excess return is expected to underperform the
benchmark by 35% in up markets and outperform by 35% during down markets.
Many utilities stocks have a beta of less than 1. Conversely, most high-tech, Nasdaq-
based stocks have a beta of greater than 1, offering the possibility of a higher rate of
return, but also posing more risk. For example, as of May 31, 2016, the
PowerShares QQQ, an ETF tracking the Nasdaq-100 Index, has a trailing 15-year
beta of 1.27 when measured against the S&P 500 Index, which is a commonly used
equity market benchmark.
Alpha is a third measure, which measures asset managers' ability to capture profit,
when a benchmark is also profiting. Alpha is reported as a number less than, equal
to, or greater than 1.0. The higher a manager's alpha, the greater his or her ability to
profit from moves in the underlying benchmark. Some top-performing hedge fund
managers have achieved short-term Alphas as high as 5 or more using the Standard
& Poor's 500 Index as a benchmark.
The Alpha and Beta of assets with R-squared figures below 50 are thought to be
unreliable because the assets are not correlated enough to make a worthwhile
comparison. A low R-squared or Beta does not necessarily make an investment a
poor choice. It merely means that its performance is statistically unrelated to its
benchmark.
R-Squared
hat is 'R-Squared'
R-squared is a statistical measure that represents the percentage of a fund or
security's movements that can be explained by movements in a benchmark index.
For example, an R-squared for a fixed-income security versus the Barclays
Aggregate Index identifies the security's proportion of variance that is predictable
from the variance of the Barclays Aggregate Index. The same can be applied to
an equity security versus the Standard and Poor's 500 or any other relevant index.
To calculate the R-squared, an analyst needs to have a "line of best fit" equation.
This equation, based on the unique date, is an equation that predicts a Y value
based on a given X value. In this example, assume the line of best fit is: y = 0.94x +
43.7
The entire set of predicted Y values is: 40.88, 34.3, 33.36, 29.6, 23.02, 23.02, 22.08,
17.38, 17.38 and 10.8. Next, the analyst takes each data point's predicted Y value,
subtracts the actual Y value and squares the result. For example, using the first data
point:
The entire list of error's squared is: 0.77, 0.49, 11.29, 5.76, 16.16, 8.88, 3.69, 21.34,
0.38 and 23.04. The sum of these errors is 91.81. Next, the analyst takes the
predicted Y value and subtracts the average actual value, which is 25.2. Using the
first data point, this is:
(40.88 - 25.2) ^ 2 = 15.68 ^ 2 = 245.86. The analyst sums up all these differences,
which in this example, equals 763.52.
Lastly, to find the R-squared, the analyst takes the first sum of errors, divides it by
the second sum of errors and subtracts this result from 1. In this example it is:
The Sharpe ratio also tends to fail when analyzing portfolios with significant non-
linear risks, such as options or warrants. Alternative risk-adjusted return
methodologies have emerged over the years, including the Sortino Ratio, Return
Over Maximum Drawdown (RoMaD), and the Treynor Ratio.
Modern Portfolio Theory states that adding assets to a diversified portfolio that
have correlations of less than 1 with each other can decrease portfolio risk without
sacrificing return. Such diversification will serve to increase the Sharpe ratio of a
portfolio.
The ex-ante Sharpe ratio formula uses expected returns while the ex-post Sharpe
ratio uses realized returns.
The Sharpe ratio can also help explain whether a portfolio's excess returns are due
to smart investment decisions or a result of too much risk. Although one portfolio or
fund can enjoy higher returns than its peers, it is only a good investment if those
higher returns do not come with an excess of additional risk. The greater a portfolio's
Sharpe ratio, the better its risk-adjusted performance. A negative Sharpe ratio
indicates that a risk-less asset would perform better than the security being
analyzed.
The Sharpe ratio can also be "gamed" by hedge funds or portfolio managers seeking
to boost their apparent risk-adjusted returns history. This can be done by:
Lengthening the measurement interval: This will result in a lower estimate of volatility.
For example, the annualized standard deviation of daily returns is generally higher
than that of weekly returns, which is, in turn, higher than that of monthly returns.
Compounding the monthly returns but calculating the standard deviation from
the not compounded monthly returns.
Writing out-of-the-money puts and calls on a portfolio: This strategy can potentially
increase return by collecting the option premium without paying off for several years.
Strategies that involve taking on default risk, liquidity risk, or other forms of
catastrophe risk have the same ability to report an upwardly biased Sharpe ratio. An
example is the Sharpe ratios of market-neutral hedge funds before and after
the 1998 liquidity crisis.)
Eliminating extreme returns: Because such returns increase the reported standard
deviation of a hedge fund, a manager may choose to attempt to eliminate the best
and the worst monthly returns each year to reduce the standard deviation.
Sharpe Ratio
The Treynor ratio shares similarities with the Sharpe ratio. The difference between
the two metrics is that the Treynor ratio utilizes beta, or market risk, to measure
volatility instead of using total risk (standard deviation).
When the value of the Treynor ratio is high, it is an indication that an investor has
generated high returns on each of the market risks he has taken. The Treynor ratio
allows for an understanding of how each investment within a portfolio is performing.
It also gives the investor an idea of how efficiently capital is being used.
Limitations
The Treynor ratio does not include any added value gained from active portfolio
management. It is simply a ranking criterion. A list of portfolios ranked based on the
Treynor ratio is useful only when considered portfolios are actually sub-portfolios of a
larger, fully diversified portfolio. Otherwise, portfolios with varying total risk, but
identical systematic risk, will be ranked or rated exactly the same.
B = the beta of the portfolio of investment with respect to the chosen market index
For example, assume a mutual fund realized a return of 15% last year. The
appropriate market index for this fund returned 12%. The beta of the fund versus that
same index is 1.2 and the risk-free rate is 3%. The fund's alpha is calculated as:
Given a beta of 1.2, the mutual fund is expected to be riskier than the index, and
thus earn more. A positive alpha in this example shows that the mutual fund
manager earned more than enough return to be compensated for the risk he took
over the course of the year. If the mutual fund only returned 13%, the calculated
alpha would be -0.8%. With a negative alpha, the mutual fund manager would not
have earned enough return given the amount of risk he was taking.
For example, assume that there is a large cap mutual fund that is
benchmarked to the Standard and Poor's (S&P) 500 index. Next, assume that
the mutual fund and the index realized the follow returns over a given five-year
period:
Given this data, the series of differences is then (11% - 12%), (3% - 5%), (12%
- 13%), (14% - 9%) and (8% - 7%). These differences equal -1%, -2%, -1%,
5%, and 1%. The standard deviation of this series of differences, the tracking
error, is 2.79%.
From an investor point of view, tracking error can be used to evaluate portfolio
managers. If a manager is realizing low average returns and has a large
tracking error, it is a sign that there is something significantly wrong with that
investment and that the investor should most likely find a replacement.
What is the 'Sortino Ratio'
The Sortino ratio is a variation of the Sharpe ratio that differentiates
harmful volatility from total overall volatility by using the asset's standard
deviation of negative asset returns, called downside deviation. The Sortino
ratio takes the asset's return and subtracts the risk-free rate, and then divides
that amount by the asset's downside deviation. The ratio was named after
Frank A. Sortino.
A ratio such as the Sharpe ratio punishes the investment for good risk, which
provides positive returns for investors. However, determining which ratio to
use depends on whether the investor wants to focus on standard deviation or
downside deviation.
Here, R equals the asset's or portfolio's annualized return, r(f) equals the risk-
free rate, and DD equals the asset's or portfolio's downside deviation.
For example, assume Mutual Fund X has an annualized return of 12% and a
downside deviation of 10%. Mutual Fund Z has an annualized return of 10%
and a downside deviation of 7%. The risk-free rate is 2.5%. The Sortino ratios
for both funds would be calculated as:
While using the risk-free rate of return is common, investors can also
use expected return in calculations. To keep the formulas accurate, the
investor should be consistent in terms of the type of return.
For an in-depth knowledge of this ratio, read Mitigating Downside With the
Sortino Ratio and 5 Ways to Rate Your Portfolio Manager.