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Investment Fundamentals: Beta

  • Beta measures the sensitivity of a security or a portfolio to the broader market’s fluctuations. 
  • As a result, investors can use beta to assess how their holdings might respond to rising and falling markets.
  • Beta can be a helpful tool for aligning portfolio holdings with an investor’s return objective and risk tolerance.

Beta measures the response of an investment (an individual security or a portfolio) to general market movements. It provides two important pieces of information—direction (positive or negative) and magnitude. When an investment’s beta is positive, it means that the investment tends to experience volatility in the same direction as the market; that is, the market and the investment tend to rise and fall together. If an investment’s beta is negative, it experiences volatility in the opposite direction as the market; when the market rises, the investment falls, and when the market falls, the investment rises. Beta also provides a numerical indication of how sensitive an investment is to market fluctuations. A beta of one indicates that an investment will generally experience the same direction and degree of volatility as the market; a beta of two implies twice the volatility, and a beta of 0.50 implies half the volatility. This relationship still holds when beta is negative, but in the opposite direction. For example, a value of -2.0 indicates that an investment will experience twice the volatility of the market but in the opposite direction.

There are other features of beta that investors should be aware of. First, the market will always have a beta of one, given that beta is calculated against the market’s returns. Second, an investment that exhibits little or no relationship to the market’s fluctuations will have a beta somewhere close to zero. And finally, an investment’s beta may change over time.

The following exhibits compare the simulated (and highly simplified) performance of a hypothetical market to that of higher- and lower-beta investments. In Exhibit 1, the hypothetical investments have betas of 0.5 and 1.5; in Exhibit 2, they have betas of -0.5 and -1.5. As Exhibit 1 shows, an investment with a beta of over 1.0 experiences more volatility (to both the upside and downside) than the overall market, while an investment with beta below 1.0 experiences less. Exhibit 2 depicts the same magnitudes, but with negative signs; investments C and D move in opposite directions to the market as a result—but with different magnitudes, depending on the numerical value of their betas.

Exhibit 1: Simulated Behavior of Positive Betas

Exhibit 2: Simulated Behavior of Negative Betas



Source: SEI

Exhibits are based on simulated hypothetical returns. Investment returns for A, B, C and D are (1) indexed to have the same starting prices and (2) assumed to be driven entirely by the market’s returns, which will not hold true with an actual investment.

What Does This Mean for Investors?

Variation among the betas of different investments can be caused by many factors. For example, industries with higher growth expectations and greater uncertainty (biotechnology, for example) tend to exhibit higher betas than more steady businesses (such as utilities). Certain sectors of the market may be more sensitive to external factors (such as interest rates) than the market in general, causing their betas to differ significantly from one. Industry or issuer-specific risks may be perceived as being higher or lower than the general market, resulting in higher or lower betas, respectively. Smaller companies tend to be viewed as riskier and, as a result, their stocks may sport betas higher than one (that is, they may tend to exhibit more volatility than the broader market).

The betas of mutual and exchange-traded funds also vary depending on their investment strategies and underlying holdings. While examining these factors can be interesting and sometimes useful, beta’s value for investors tends to arise from its role in portfolio construction. Like any statistical measure, it should not be used in isolation. But when used properly, it can provide helpful insights into the riskiness of individual securities, the expected impacts of individual securities on a diversified portfolio’s volatility and returns, and the expected riskiness of a portfolio relative to the broader market.

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SEI Investments (Europe) Limited acts as distributor of collective investment schemes which are authorised in Ireland pursuant to the UCITS regulations and which are collectively referred to as the “SEI Funds” in these materials. These umbrella funds are incorporated in Ireland as limited liability investment companies and are managed by SEI Investments Global, Limited, an affiliate of the distributor. SEI Investments (Europe) Limited utilises the SEI Funds in its asset management programme to create asset allocation strategies for its clients. Any reference in this document to any SEI Funds should not be construed as a recommendation to buy or sell these securities or to engage in any related investment management services. Recipients of this information who intend to apply for shares in any SEI Fund are reminded that any such application must be made solely on the basis of the information contained in the Prospectus (which includes a schedule of fees and charges and maximum commission available). Commissions and incentives may be paid and if so, would be included in the overall costs. A copy of the Prospectus can be obtained by contacting your Financial Advisor, SEI Relationship Manager or by using the contact details shown below.

Past performance is not a guarantee of future performance. Investors may not get back the original amount invested. If the investment is withdrawn in the early years, it may not return the full amount invested. This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events.

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