Beta

A measure of a fund's sensitivity to market movements.

The beta of the market is 1.00 by definition. Morningstar calculates beta by comparing a fund's excess return over Treasury bills to the market's excess return over Treasury bills, so a beta of 1.10 shows that the fund has performed 10% better than its benchmark index in up markets and 10% worse in down markets, assuming all other factors remain constant.

Conversely, a beta of 0.85 indicates that the fund's excess return is expected to perform 15% worse than the market's excess return during up markets and 15% better during down markets.

Beta can be a useful tool when at least some of a fund's performance history can be explained by the market as a whole. Beta is particularly appropriate when used to measure the risk of a combined portfolio of mutual funds.

It is important to note that a low beta for a fund does not necessarily imply that the fund has a low level of volatility. A low beta signifies only that the fund's market-related risk is low. (Standard deviation is a measure of a fund's absolute volatility.)

A specialty fund that invests primarily in gold, for example, will usually have a low beta, as its performance is tied more closely to the price of gold and gold-mining stocks than to the overall stock market. Thus, the specialty fund might fluctuate wildly because of rapid changes in gold prices, but its beta will remain low.

R-squared is a necessary statistic to factor into the equation, because it reflects the percentage of a fund's movements that are explained by movements in its benchmark index.

Example: A fund has an alpha of 0.86, a beta of 0.96, and an R-squared of 97. The high R-squared lends further credibility to the accuracy of the fund's alpha and beta. The beta of 0.96 indicates the fund's performance is very close to that of the market, which would be represented by 1.00.