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By Wendy Stein | 04-20-2018

The Morningstar Dictionary: Beta

Beta gives you a sense of how volatile an investment has been, compared to a benchmark.

Wendy Stein: Beta is one of the five risk ratios that are used in Modern Portfolio Theory. The others are alpha, Standard Deviation, the Sharpe Ratio and R-squared. Beta, along with the other risk ratios, can help investors assess the risk-return profile of investments. You can find them in the MPT Statistics section of the Risk and Ratings tab of a fund or ETF's Morningstar Report on

Beta gives you a sense of how volatile an investment has been, compared to a benchmark. It's calculated by comparing an investment's excess return over a risk-free rate to the benchmark's excess return. Funds with high beta have been more volatile than the benchmark and funds with low beta have been less volatile than the benchmark.

The table shows the performance of three hypothetical funds, with different betas, in an up-market scenario and a down-market scenario. In a nutshell, funds with high beta will deliver higher returns when markets are rising and worse returns when markets are falling. Funds with low beta will protect better on the downside but you lose out on the upside, compared to the benchmark.

Beta comes with a significant caveat – it is only useful when the benchmark and the fund used in the calculation are comparable. You wouldn't, for example, combine an equity fund with a fixed income benchmark to calculate beta. Some funds, for example go-anywhere fixed income funds, don't have natural benchmarks. If a fund is being compared with an inappropriate benchmark, its beta is meaningless. You can gauge how comparable a fund is to the benchmark being used to calculate beta with one of the other MPT statistics: R-squared.

Another important caveat is that beta is a relative risk measurement. Low beta does not mean that the fund has a low level of volatility on an absolute basis, rather that its volatility relative to the benchmark is low.

Assuming the investment represents a desired market or asset class exposure, the benchmark is comparable and low volatility is important, conservative investors may find beta to be a helpful analytic.

For Morningstar, I'm Wendy Stein.