What is a High Beta Index?

What is a High Beta Index?

A high beta index is a basket of stocks that exhibits greater volatility than a broad market index such as the S&P 500 Index. The S&P 500 High Beta Index is the most well-known of these indexes. It tracks the performance of 100 companies in the S&P 500 that are the most sensitive to changes in market returns.

Beta is the amount of volatility or systematic risk an asset exhibits compared to the market as a whole. Besides the flagship large-cap index, Standard and Poor’s offers a number of high beta variations for small-cap, mid-cap and other market indexes.

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.

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Limitations of a High Beta Index

Contrary to popular belief, high beta or volatility doesn’t necessarily translate into greater returns. For many years, the High Beta S&P 500 Index has underperformed its underlying benchmark.

This occurred during a period of unyielding improvement in the broader market.

Instead, research shows that low volatility stocks tend to earn greater risk-adjusted returns than high volatility stocks. The reason low beta tends to outperform can be attributed to investment behavioral biases, such as the representative heuristic and overconfidence. In addition, sector selection and other fundamental criteria play an important role in the volatility and performance of a high beta index.

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