High Beta Index

A market index that is made up of stocks with higher than average volatility as compared to the overall stock market

What is a High Beta Index?

A high beta index refers to a market index made up of stocks with higher-than-average volatility compared to the overall stock market. Examples include the S&P 500 High Beta Index, the TSX Composite High Beta Index, the Hang Seng High Beta Index, and the S&P Emerging Markets High Beta Index.

 

High Beta Index

 

Investors can access the S&P 500 High Beta Index through the Invesco S&P 500 High Beta Index ETF. This exchange-traded fund tracks the 100 stocks in the S&P 500 that have shown the highest beta readings over the previous 12 months. Approximately one-third of the fund’s holdings consist of stocks of publicly-traded companies in the financial services sector.

 

Summary

  • A high beta index refers to a market index that is made up of stocks with higher-than-average volatility as compared to the overall stock market.
  • Some investors aim to maximize returns on investment by investing in high beta stocks, especially during periods when the overall stock market is extremely bullish.
  • High beta stocks may offer greater potential profits but also include exposure to greater risk.

 

Understanding Beta

Beta is considered a measurement of systematic risk, which applies to the broad stock market rather than just to an individual stock. However, beta is actually more of an indicator of volatility. For example, the overall stock market might experience a day when major market indexes gradually rise and close 2% higher on the day.

During the same day, a high beta stock might rise in price 5%, be down 2% on the day, then be up 3%, and eventually close with the same gain as the overall market – 2%. Although the stock ended the day with a gain in price equal to that of the overall market, it did, during the trading day, offer investors the opportunity to sell out their position in the stock for a significantly greater gain of 5%.

A beta reading of 1 means that a stock roughly moves in tandem with the overall stock market. Thus, if a major market index such as the S&P 500 is up or down 3%, then the stock is also likely to be up or down approximately 3%. Beta readings between 0 and 1 indicate a stock is likely to experience less up and down movement than the overall stock market.

On the other hand, beta readings greater than 1 (most beta readings of stocks fall between 0 and 3) indicate that a stock is likely to experience greater up and down swings in price than the overall stock market exhibits. A stock with a beta reading of 2 is approximately twice as volatile in its price movements as the overall stock market is.

Although it is rare, a stock may have a negative beta reading. A negative beta value indicates that a stock’s price movements tend to have a negative directional correlation with the overall stock market. In other words, the stock tends to rise when the overall market falls and to fall when the overall market rises.

 

Why Investors Like High Beta Index Stocks

Investors look to the stocks contained in a high beta index in hopes of attaining better than market average returns on investment. Such investors often focus on high beta stocks when the overall stock market is highly bullish, looking to maximize potential gains from the greater volatility that such stocks are likely to exhibit.

However, with the potential for higher returns also comes higher risk, as both gains and losses can be amplified compared to the overall stock market. During bear markets, investors tend to shy away from high beta stocks, as they may suffer greater losses than the overall stock market.

In fact, when adjusted for risk, some studies indicate that low beta stocks outperform high beta stocks over the long term. However, it doesn’t mean that investors might not achieve higher returns on investment by taking maximum advantage of the greater volatility exhibited by high beta stocks.

 

Keep Learning

CFI is the official provider of the global Capital Markets & Securities Analyst (CMSA)® certification program, designed to help anyone become a world-class financial analyst. To keep advancing your career, the additional resources below will be useful:

  • Alpha
  • Implied Volatility (IV)
  • Market Risk
  • Smart Beta ETF

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