When Beta Is Meaningful
Chart of the Week for March 24-30, 2000
Beta is a statistical measure that indicates the degree of variability of an asset’s returns as compared to the returns of a market benchmark. More simply put, it tells us whether one particular fund is has more or less market risk than its benchmark, typically the S&P 500 Index. When beta is greater than one, a fund has greater sensitivity to market factors than the S&P 500 Index; when beta is lessthan one, it has less sensitivity.
The beta for the American Century Ultra Fund for the 10 years ending December 1999 is 1.3, meaning the fund has approximately 1.3 times the variability of the S&P 500 Index. We can get a glimpse of this relationship in the graph above, which shows the year-to-date daily returns of the S&P 500 Index and the American Century Ultra Fund. As you can see, the Fund generally moves in the same direction as the Index, but has “higher highs” and “lower lows,”which we would expect from an asset with a higher beta.
The statistical measure R2, or “R-squared,” goes hand-in-hand with beta. R2 indicates how much of the variability in the asset’s returns can be explained by variability in the benchmark’s returns. R2 is always between zero and one, and the closer it is to one, the stronger the relationship is. In other words, the greater the R2, the more beta can be relied upon to explain past variability. The R2 of the Fund/Index relationship above is 0.7, so the beta is a reasonably good measure, but other factors contributed to variability as well.
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