Portfolio Metrics: Beta
You may all have noticed the new tags on the site with “Covestor” listed. Basically, it’s a trade-sharing service which seeks to gives investing enthusiasts a way to establish an investment track record by both providing a third-party validation of returns as well as reporting of conventional portfolio performance metrics. I’ll discuss the site more in a later post as I’m still playing around with it, but the site has inspired me to share a bit about portfolio performance and how you can calculate simple metrics at home to see if your investment strategies are working as you have designed them to. At the end of this little series of posts, I’ll provide a simple Excel sheet that I’ve built to calculate my own return results which you can use as well.
The most common and most talked about return metric is beta and, to a degree, its what many other portfolio performance metrics are based on. Essentially, it is a measure of the systemic risk caused by the market. That is, how much certain changes in the broad markets affect the security or portfolio in question. Put simply, and in the terms most people like to use to describe beta, it is a measure of the volatility of your portfolio relative to the market.
Beta is backward looking and calculated through regression analysis. As a result, it can be helpful for stable, long-term strategies but is often less than meaningful for people who are trading regularly or changing their investment strategies or styles on a regular basis.
To calculate beta, you need your historical results on some sort of time period basis. Typically, this is done per month but for more detail you could do it on a per day basis. You also need corresponding returns of a benchmark index. Typically speaking, beta refers to volatility versus the S&P 500 index. Let the S&P 500 returns be x-axis points and your portfolio returns be the y-axis points. Then, you simply graph the set of linear pairs and have whatever system you are using draw regression line. The slope of this line is your beta which shows how much your portfolio moves relative to a change in the underlying index.
For those with a statistics background, you may know this to be representative of the covariance of between the portfolio return and the market return divided by the variance of the market. That is, ? (beta) = Cov (ri, rm) / Var (rm)
Basically, a beta of 1 means that market movements correspond to the same movement in the portfolio. A beta greater than 1 means that the portfolio is more sensitive to changes in the market. A beta less than 1 means that the portfolio is less sensitive to changes in the market. For example, a beta of .6 would imply that when the market moves 1% in either direction your portfolio only moves .6%. A negative beta implies that the portfolio moves in the opposite direction to that of the market.
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[...] stock or a portfolio’s volatility relative to the market overall. Please refer to the post on calculating beta for an in depth look at how to calculate [...]