Taking The Measure
As a careful investor, you have probably studied mutual-fund prospectuses to find funds with growth or income objectives matching yours. But chances are such terms as "conservative," "speculative," or "above-average risk" left you puzzled. Just how conservative? How speculative? And what's average risk, anyway?
Enter the beta--a risk designation becoming so common among portfolio managers that the Securities & Exchange Commission is pondering whether funds should note it in the prospectus. A beta is a measure of a fund's riskiness that's expressed as follows: 1.00, 1.25, .85, or the like. The number is derived from two factors: the fund's volatility over a period of years and its correlation with the movement of the broad stock market.
The fund-vs.-market relationship is what makes the beta a significant indicator--useful along with net asset value, dividends, and other factors in choosing a fund. Analysts calculate betas with a formula that sets 1.00 as a base for the market. So if a fund's beta is 1.00, it will, on average, move with the market--rising 10% if the market rises 10%, for example.
A fund with a beta of 1.5 is 50% more volatile than the market: A 10% rise in the market might foster a 15% gain in the fund; a 10% market decline, a 15% drop in the fund. A beta below 1.00 indicates the fund is less likely to rise as high as the market does, but shouldn't fall as hard if the market tumbles.
MARKET WATCH. Astute investors know the past is no guarantee of future performance. And betas are most useful in gauging risk among diversified equity funds--not international or gold funds, utility funds, and others whose volatility may be unrelated to the market's.
Keeping that in mind, here's how a beta can figure into an investment decision. For a short-term investment, it might seem risky to choose a fund with a history of wide price swings. But if its beta indicates the fluctuations more or less parallel the market's--and if you feel confident the market is headed up--you could conclude the risk is worth taking.
Helpful as a beta can be, not all managers order up the calculation. "We don't use them," says a spokesperson for Invesco's Financial Funds, "because some funds use the S&P 500 as a base, others use the Dow, and others use their own index." But you can check many funds's betas in such guides as The Individual Investor's Guide to No-Load Mutual Funds ($24.95, 312 280-0170) or the biweekly Mutual Fund Values ($55 for three months, 800 876-5005). Or call the fund's 800 number that also supplies its price and earnings data.
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