How to use alpha and beta for your own investment portfolio If you actively invest in mutual funds or stocks, understanding alpha values can help you gauge their performance. For stock investors, beta values can help you better gauge risk levels and structure your investment portfolio appropriately.
Full Answer
Which bank is better for mutual fund?
Usually, mutual fund schemes outscore during positive market conditions, and underscore bank FDs during negative market conditions. So you should consider your risk appetite while opting between bank's fixed deposits and mutual funds. Mutual funds unlike, bank FDs do not come with insurance and credit guarantee.
What does beta mean in reference to mutual funds?
Where:
- y is the performance of the stock or fund.
- a is alpha, which is the excess return of the stock or fund.
- b is beta, which is volatility relative to the benchmark.
- x is the performance of the benchmark, which is often the S&P 500 index.
- u is the residual, which is the unexplained random portion of performance in a given year.
Which mutual funds are better for investment?
Now, let's look at the most notable downsides with cryptocurrency mutual funds:
- There are hardly any available. Right now, there's only a Bitcoin mutual fund. ...
- Cryptocurrency is extremely volatile. While you could make a lot of money from crypto, prices could also plummet. ...
- You don't own cryptocurrencies. ...
- Expense ratios can be high. ...
How can risky a mutual fund be?
UTI mutual fund was one of the affected houses in the debt crisis ... So, I would actually argue that, with the present level of stability returning to the markets, you can start seeing credit risk funds coming back into favour.
How do you interpret the beta for the stock and the mutual fund?
A beta of less than 1.0 indicates that the investment will be less volatile than the market. Correspondingly, a beta of more than 1.0 indicates that the investment's price will be more volatile than the market. For example, if a fund portfolio's beta is 1.2, it is theoretically 20% more volatile than the market.
What is a good alpha ratio for a mutual fund?
Anything more than zero is a good alpha; higher the alpha ratio in mutual fund schemes on a consistent basis, higher is the potential of long term returns. Generally, beta of around 1 or less is recommended.
What should be beta in mutual fund?
The beta of the market or benchmark is always taken as 1. Any beta less than 1 denotes lower volatility and higher than 1 denotes more volatility compared to the benchmark index. For example, if your mutual fund portfolio XYZ has a beta of 0.70, it denotes lower volatility.
What is alpha and beta value in mutual fund?
Alpha measures the excess or deficit in a fund's performance against a benchmark index. Beta is a measure of fluctuations in the fund against the fluctuations in a benchmark index. Alpha and Beta are used to calculate a mutual fund's performance and stability with respect to the equity market.
Should my beta be high or low?
A stock that swings more than the market over time has a beta above 1.0. If a stock moves less than the market, the stock's beta is less than 1.0. High-beta stocks are supposed to be riskier but provide higher return potential; low-beta stocks pose less risk but also lower returns.
How do you Analyse a mutual fund performance?
Attribution AnalysisStep 1: Determine the sector weights for both the fund and the index.Step 2: Calculate the contribution of each sector for the fund by multiplying the sector weight by the sector return. ... Step 3: Calculate the rate of return for the fund by adding the contribution of each sector together.More items...
How do investors use beta?
A security's beta is calculated by dividing the product of the covariance of the security's returns and the market's returns by the variance of the market's returns over a specified period. The beta calculation is used to help investors understand whether a stock moves in the same direction as the rest of the market.
Does beta affect mutual funds?
A mutual fund's beta is a measure of how volatile an investor can expect the fund to be compared to the overall market. A beta of more than one means that the fund is more volatile than the overall market, and a beta of less than one means that it is less volatile.
What is negative alpha in mutual fund?
Alpha is an important tool for many investors when trying to figure out if their investments are doing well. A positive alpha indicates the security is outperforming the market. Conversely, a negative alpha indicates the security fails to generate returns at the same rate as the broader sector.
Is alpha better than beta?
Key Takeaways. Both alpha and beta are historical measures of past performances. A high alpha is always good. A high beta may be preferred by an investor in growth stocks but shunned by investors who seek steady returns and lower risk.
How is mutual fund alpha calculated?
The alpha Mutual Funds formula is (End Price + DPS – Start Price)/Start Price. Here, DPS is Distribution per share. Alpha can be calculated alternatively by using CAPM. As CAPM is indicative of the expected returns from a specific fund, any figure deviating from the same is the alpha.
What does beta mean in stocks?
Beta indicates how volatile a stock's price has been in comparison to the market as a whole. A high alpha is always good. A high beta may be preferred by an investor in growth stocks but shunned by investors who seek steady returns and lower risk. 1:26.
What does it mean when a stock has a beta of 1.5?
If a stock's beta is 1.5, it is considered to be 50% more volatile than the overall market. Like alpha, beta is a historical number.
What is beta in investing?
Beta: An Overview. Alpha and beta are two of the key measurements used to evaluate the performance of a stock, a fund, or an investment portfolio. Alpha measures the amount that the investment has returned in comparison to the market index or other broad benchmark that it is compared against. Beta measures the relative volatility of an investment. ...
What does alpha of 1.0 mean?
An alpha of 1.0 means the investment outperformed its benchmark index by 1%. An alpha of -1.0 means the investment underperformed its benchmark index by 1%. If the alpha is zero, its return matched the benchmark. Note, alpha is a historical number.
What is the purpose of beta?
Beta measures the relative volatility of an investment. It is an indication of its relative risk. Alpha and beta are standard calculations that are used to evaluate an investment portfolio’s returns, along with standard deviation, R-squared, and the Sharpe ratio .
What is the formula for beta?
Formula for Beta. Covariance is used to measure the correlation in price moves of any two stocks. A positive covariance means the stocks tend to move in lockstep, while a negative covariance means they move in opposite directions. Variance refers to how far a stock moves relative to its mean.
Is Coca Cola more volatile than Apple?
Coca-Cola Company ( KO): 0.61. Apple Inc. ( AAPL ): 1.18. We can see that Micron is 26% more volatile than the market as a whole, while Coca-Cola is 37% as volatile as the market, and Apple is more in line with the market or 0.01% less volatile than the market. Acceptable betas vary across companies and sectors.
What is the beta of a stock?
Beta. Beta, also known as the beta coefficient, is a measure of the volatility, or systematic risk, of a security or a portfolio, compared to the market as a whole. Beta is calculated using regression analysis and it represents the tendency of an investment's return to respond to movements in the market. By definition, the market has a beta of 1.0.
What is alpha in investing?
Alpha is a measure of an investment's performance on a risk-adjusted basis. It takes the volatility (price risk) of a security or fund portfolio and compares its risk-adjusted performance to a benchmark index. The excess return of the investment relative to the return of the benchmark index is its alpha. Simply stated, alpha is often considered ...
What is standard deviation in investing?
Standard deviation measures the dispersion of data from its mean. Basically, the more spread out the data, the greater the difference is from the norm. In finance, standard deviation is applied to the annual rate of return of an investment to measure its volatility (risk). A volatile stock would have a high standard deviation. With mutual funds, the standard deviation tells us how much the return on a fund is deviating from the expected returns based on its historical performance.
What are the indicators of investment risk?
They are alpha, beta, r-squared, standard deviation and the Sharpe ratio. These statistical measures are historical predictors of investment risk/ volatility and they are all major components of modern portfolio theory (MPT).
How to calculate Sharpe ratio?
It is calculated by subtracting the risk-free rate of return (U.S. Treasury Bond) from the rate of return for an investment and dividing the result by the investment's standard deviation of its return.
What should conservative investors focus on?
Conservative investors who wish to preserve capital should focus on securities and fund portfolios with low betas while investors willing to take on more risk in search of higher returns should look for high beta investments.
What does a beta of 1.0 mean?
A beta of 1.0 indicates that the investment's price will move in lock-step with the market. A beta of less than 1.0 indicates that the investment will be less volatile than the market. Correspondingly, a beta of more than 1.0 indicates that the investment's price will be more volatil e than the market. For example, if a fund portfolio's beta is 1.2, ...
What is the purpose of beta in mutual funds?
Beta, however, measures how volatile a specific investment is compared to an index. Alpha is often used to compare mutual funds. 1 If you want to know how a mutual fund has performed in the past compared to the S&P 500 index, you can use the alpha to measure whether the fund overperforms or underperforms.
What is the difference between alpha and beta?
The main difference between the two is that alpha is used to identify performance relative to an index, while beta identifies volatility relative to an index.
What is the purpose of Alpha and Beta?
Alpha and beta are both measurements used by investors to compare the performance and volatility of an underlying security. Alpha helps investors measure the performance of a fund in comparison to an index or another fund. Beta helps investors determine the volatility of a security in comparison to an index so they can further align their ...
Why do we use beta?
Beta helps investors determine the volatility of a security in comparison to an index so they can further align their investments with their risk tolerance . When using alpha and beta, keep in mind that the measurements are based on historical data and do not indicate the future movement of a stock or fund.
What does a higher beta mean?
A higher beta means a riskier investment with the potential of higher returns, while a lower beta means a more conservative investment with lower expected returns. A beta of 1.0 means the asset has the same volatility as the index. If the beta is 1.2, it indicates that the investment is 20% more volatile than the index.
What does 1.2 mean in a stock?
If the beta is 1.2, it indicates that the investment is 20% more volatile than the index. If the beta is 0.8, it indicates that the investment is 20% less volatile than the index.
What is beta in mutual funds?
Beta is a measure of the responsiveness of a mutual fund vis-a-vis its benchmark index. It points out how sensitive a mutual fund is to the fluctuations in the benchmark index. The idea behind the indicator Beta is to gauge the stability of the mutual fund. A mutual fund should not take wild swings and should be capable ...
What is an alpha fund?
In some ways, Alpha is a measure of the performance of the fund manager itself. It measures the endeavours put in by the fund manager to drive the fund to yield handsome returns.
What does a beta of 1 mean?
A beta of 1 indicates that the mutual fund shows the same deviations as the benchmark index. A beta > 1 means the mutual fund is overly responsive to the benchmark index. For example, if a fund portfolio’s beta is 1.2, it is theoretically 20% more volatile than the market. A beta < 1 indicates that the fund is relatively stable ...
What does an alpha above 0 mean?
An alpha above 0 indicates the asset manager has outperformed the benchmark. A beta of above 1 means the fund is more responsive to market volatility than the benchmark. A beta under 1 means the fund is less responsive to market volatility than the benchmark.
Is past performance an assurance that the fund will perform in the future?
Though past performance is not an assurance that the fund will perform in the future, it still gives a baseline to compare the mutual fund among its peers. When gauging the fund’s history and track record, ratios like Alpha and Beta are of great help.
What is the Alpha and Beta of a capital asset?
Alpha and beta are two key elements of the Capital Asset Pricing Model, which can help you decide if an investment is worth its risk. You can learn more about these two elements in SmartAsset’s articles on alphaand beta. There’s also a helpful article about another key investing metric called delta.
What does a beta of 1.0 mean?
A beta of 1.0 means that the stock is just as volatile as the market overall. If a benchmark index fund changes its price by $1, this stock has historically changed its price by $1, too; A beta of 1.5 means that the stock is 50 percent more volatile than the market.
What does 0.0 mean in stocks?
A beta of 0.0 means that the stock is almost entirely without volatility. Even if a benchmark index fund changes its price by $1, this asset has historically not moved. This is most typically associated with cash. An asset can also have a negative beta.
Does beta tell you if a stock is underperform?
Beta does not tell you whether Stock A tended to outperform the market, underperform it or both. Beta, Volatility and Risk. Beta is considered a measure of systemic vs. unsystemicrisk in an asset. Systemic risk measures the risk that all assets in a marketplace share.
Is the S&P 500 benchmark a benchmark?
Benchmark. The S&P 500is by far the most common benchmark to use, but it isn’t required.
What is an alpha fund?
"Alpha" is another common term you'll see when researching investments, particularly mutual funds. Unlike beta, which simply measures volatility, alpha measures a portfolio manager’s ability to outperform a market index. Alpha is a measure of the difference between a portfolio's actual returns and its expected performance, given its level of risk as measured by beta.
How does beta work?
Of course, beta works both ways. If the S&P 500 falls 10%, a stock with a beta of 1.2 is expected to fall by 12%. Generally, the higher a stock's beta, the more volatile it is. While a stock's beta measures its volatility, it does not necessarily predict direction.
What is smart beta?
Smart beta refers to an enhanced indexing strategy that seeks to exploit certain performance factors in an attempt to outperform a benchmark index. In this sense, smart beta differs fundamentally from a traditional passive indexing strategy.
What does a beta of 1.0 mean?
A stock with a beta of 1.0 indicates that it moves in tandem with the S&P 500. If a stock's performance has historically been more volatile than the market as a whole, its beta will be higher than 1.0. For example, a stock with a beta of 1.2 is 20% more volatile than the market.
What is the beta of the S&P 500?
The term "beta" is simply a measure of a stock's sensitivity to the movement of the overall stock market. The beta of the S&P 500 is expressed as 1.0. The beta of an individual stock is based on how it performs in relation to the index's beta.
What is factor in stocks?
A factor is simply an attribute that might help to drive risk or returns, such as quality or size. For example, stocks of companies that generate superior profits, strong balance sheets, and stable cash flows are considered high quality, and tend to outperform the market over time.
What is the difference between beta and alpha?
Beta is the return generated from a portfolio that can be attributed to overall market returns. Exposure to beta is equivalent to exposure to systematic risk. Alpha is the portion of a portfolio's return that cannot be attributed to market returns and is thus independent of them. Exposure to alpha is equivalent to exposure to idiosyncratic risk.
How to get beta exposure?
There are three basic ways to obtain beta exposure: buy an index fund, buy a futures contract, or buy some combination of both an index fund and futures contracts. There are advantages and disadvantages to each option.
What is the difference between alpha and systematic risk?
Exposure to alpha is equivalent to exposure to idiosyncratic risk. Systematic Risk is the risk that comes from investing in any security within the market. The level of systematic risk that individual security possesses depends on how correlated it is with the overall market. This is quantitatively represented by beta exposure.
What is pure alpha?
Some strategies that exemplify the definition of pure alpha are statistical arbitrage, equity neutral hedged strategies and selling liquidity premiums in the fixed-income market.
Does the S&P 500 have a beta?
This is because the S&P 500 represents the overall market, which means that it will have a beta of 1. Choosing a beta exposure is highly individual, and will be based on many factors. If a manager was benchmarked to some sort of market index, that manager would probably opt to have a high level of beta exposure.
Is there a time limit on buying index futures?
The advantage, however, is that there is no limited time horizon on buying an index fund itself. When buying index futures to obtain beta exposure, an investor only needs a portion of the cash to control the same sized position as buying the index itself.
What is the difference between beta and alpha?
Beta, another useful statistical measure, compares the volatility (or risk) of a fund to its index or benchmark . The R-squared of a fund shows investors if the beta of a mutual fund is measured against an appropriate benchmark. Alpha measures how much , if any , extra risk helped the fund outperform its corresponding benchmark.
What does it mean when a fund has a beta of one?
A fund with a beta very close to one means the fund's performance closely matches the index or benchmark. A beta greater than one indicates greater volatility than the overall market, and a beta less than one indicates less volatility than the benchmark.
What is the difference between standard deviation and beta?
Beta. While standard deviation determines the volatility of a fund according to the disparity of its returns over a period of time, beta, another useful statistical measure, compares the volatility (or risk) of a fund to its index or benchmark. A fund with a beta very close to one means the fund's performance closely matches the index or benchmark.
How to determine if a fund has an optimal return?
To determine if the proposed fund has an optimal return for the amount of volatility acquired, an investor needs to do an analysis of the fund's standard deviation. Modern portfolio theory and volatility are not the only means investors use to analyze the risk caused by many different factors in the market.
Why is beta skewed?
Beta by itself is limited and can be skewed due to factors other than the market risk affecting the fund's volatility. 3. R-Squared. The R-squared of a fund shows investors if the beta of a mutual fund is measured against an appropriate benchmark.
What is standard deviation in investing?
The standard deviation essentially reports a fund's volatility, which indicates the tendency of the returns to rise or fall drastically in a short period of time. A volatile security is also considered a higher risk because its performance may change quickly in either direction at any moment.