Beta in Mutual Fund

Understanding the risk associated with a mutual fund is important before making an investment decision. One useful measure for this is beta, which shows how much a mutual fund’s returns may move compared with its benchmark. A beta of 1 indicates that the fund has historically moved in line with its benchmark, while a beta above or below 1 suggests higher or lower volatility, respectively. For example, a beta of 1.5 means the fund has historically been 50% more volatile than its benchmark. Knowing beta in mutual fund analysis can help investors compare a scheme’s historical volatility with the broader market. However, beta is based on past data and does not guarantee how the fund will perform in the future. Investors should consider beta along with other risk and performance factors before investing.

In summary

Beta helps you understand a mutual fund’s historical volatility compared with its benchmark. A beta of 1 means the fund has moved in line with the benchmark, while 1.5 indicates 50% higher volatility.

• Beta above 1 indicates higher historical volatility than the benchmark.
• Beta below 1 indicates lower historical volatility.
• A negative beta suggests the fund has historically moved opposite to its benchmark.
• Beta is based on historical returns and does not predict future performance.
• It should be considered with other risk and performance measures.

Mutual Fund investments are subject to market risks, read all scheme related documents carefully.

Before investing, compare beta with your investment goals, risk tolerance and other relevant fund factors.

What is beta in a mutual fund

Beta in a mutual fund measures how much the fund’s returns fluctuate compared to its benchmark index. The benchmark always has a beta value of 1. If a mutual fund also has a beta of 1, its returns are expected to move in line with the benchmark. For example, if the benchmark delivers a return of 10%, the fund is also likely to generate around 10%. A beta of 1.5 indicates that the fund may rise or fall by 15% when the benchmark moves by 10%. Therefore, a beta above 1 suggests higher volatility than the market, while a beta below 1 indicates lower volatility.

Beta helps investors understand how a mutual fund is likely to perform relative to market movements. It measures the fund’s sensitivity to changes in its benchmark and reflects its level of risk. A higher beta may offer the potential for greater returns during favourable market conditions but can also result in larger losses when markets decline. Investors should select funds with beta values that match their financial goals and risk tolerance. Together, alpha, which reflects the fund manager’s skill, and beta, which reflects market-driven returns, contribute to the fund’s overall performance.

How beta works in mutual funds

Now that you know what the beta in mutual funds indicates, let us delve into the finer details of this analytical tool. Since the beta is based on the past performance of a mutual fund and its benchmark or the broad market, you can get a better idea of the fund’s historical risk.

When you are choosing funds for your portfolio, irrespective of whether you want to make a lump sum investment or start an SIP, you need to evaluate the beta and check if the risk taken is justified by the excess returns you earn from the fund — when compared with its benchmark. The alpha of the mutual fund quantifies this risk-adjusted return.

Importance of beta in mutual funds

Beta is vital in mutual fund analysis because it helps you assess the level of risk in a fund relative to the market. You can use beta to understand the expected movements of a fund in relation to market changes. This, in turn, helps you make informed decisions about risk and return. expectations and is essential for constructing a well-balanced portfolio.

For mutual fund managers, beta is a key tool for performance evaluation. By assessing a fund's beta, fund managers can determine how well they are handling the fund's volatility in comparison to the market. This helps them develop strategies that align with the fund's objectives — whether it's aiming for aggressive growth or stable income.

Additionally, beta values also help with portfolio diversification. By combining funds with different beta values, you can create a balanced portfolio that has well-distributed risk and the potential for enhanced returns.

Beta in mutual funds also plays a crucial role in risk management. By selecting funds with appropriate beta levels, you may tailor your portfolios to match your risk tolerance. For instance, during market downturns, funds with lower beta can help mitigate losses, while those with higher beta might offer more upside during bullish phases.

Types of beta values and what they mean

Interpreting beta values can seem complex for beginners because you need to assess the value as well as the direction of the result. However, this handy guide can help you interpret beta in mutual funds at a glance.

Beta = 1: A beta value of 1 means that the mutual fund is exactly as volatile as its benchmark. This limits the risk in the fund but also reduces the possibility of earning excess returns over and above the benchmark returns.

Beta > 1: If the beta in a mutual fund is more than 1, it means that the fund has more volatility than its benchmark. This increases the risk involved. For instance, a beta of 1.6 indicates that the fund moves 0.6 times or 60% more than its benchmark index.

Beta < 1: A beta value below 1 means that the fund is less volatile than its benchmark index. This translates to a low level of risk. For example, if a mutual fund has a beta of 0.8, it means the fund is 0.2 times or 20% less volatile than the benchmark considered.

Negative and positive beta: In addition to the absolute value of the beta in mutual funds, you must also check whether it is positive or negative. Positive beta values indicate that the fund and the market move in the same direction, while negative beta values indicate that the two move in opposite directions.

Beta formula and calculation

The beta in a mutual fund is a ratio of two statistical measures. The numerator is the covariance of the mutual fund’s returns with the benchmark’s returns over a given period, while the denominator is the variance of the benchmark’s returns over the same period. This leads us to the following beta formula in mutual funds:

Beta = (Covariance of the fund’s returns with the benchmark’s returns) ÷ Variance of the benchmark’s returns

The covariance in the numerator measures how the fund’s returns change relative to the benchmark index’s returns. The variance in the denominator of the beta formula in mutual funds tells you how much the benchmark’s returns vary in the given period.

Beta example

Let us discuss an example to understand how to calculate beta. Let us say the covariance between the returns of a mutual fund and the returns of its benchmark index is 0.0025. The covariance measures how much two variables change together. In this context, it shows how the returns of the mutual fund move in relation to the benchmark’s returns.

Next, we need the variance of the benchmark’s returns, which measures how much the benchmark’s performance fluctuates over time. Let us assume this is 0.002.

Substituting these values in the beta formula for mutual funds, this is what we have.

Beta: 

= (Covariance of the fund’s returns with the benchmark’s returns) ÷ Variance of the benchmark’s returns

= 0.0025 ÷ 0.002

= 1.25

This means the beta of the mutual fund is 1.25. In other words, the mutual fund’s volatility is 25% more than its benchmark. If the benchmark’s return changes by 1%, the fund's return is expected to change by 1.25%.

What does a high or low beta indicate?

Beta helps investors understand how much a mutual fund’s performance may vary compared to the market. Here's what different beta values suggest:

A higher beta implies greater market-linked risk—but also the potential for better returns.

Things to keep in mind about beta in mutual funds

Here are some important things you need to keep in mind about beta before you invest in mutual funds:

Relative risk measure

Beta is a relative measure that compares a mutual fund's volatility to the broader market. It can give you some information about a mutual fund’s risk levels on a standalone basis, but you may also use it to compare how a fund’s volatility compares to the industry or category average.

Beta-based diversification

You may even use beta values to diversify your portfolio. By including funds with different beta values, you can balance out the overall risk in your investments. For instance, combining high-beta funds with low-beta funds can help mitigate risk while potentially enhancing returns.

Link to market conditions

Beta values are not fixed. They can vary based on market conditions. During bull markets, for instance, high-beta funds may outperform the market while low-beta funds may lag. In bear markets, the opposite is often true.

Long-term outlook

You need to remember that beta in mutual funds is only one part of a broader investment strategy. While low-beta funds may offer more stability, they may also provide lower long-term returns. However, while high-beta funds may offer greater growth potential, they are riskier.

Conclusion

This sums up what beta in mutual funds is and how you can compute and interpret it. If you are a conservative investor, you may want to consider funds with a low beta value. On the other hand, if you are comfortable taking risks, a fund with a high beta may also be suitable for you — provided its risk-adjusted returns are high.

Irrespective of your risk tolerance and beta preferences, you can find a suitable mutual fund scheme for your portfolio on the Bajaj Broking website. With more than 4,000 schemes available to choose from, comparing and making an informed choice has never been easier.

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