Tag Archives: beta

Comparing my assets with its benchmark: some figures for analysis

Comparative figures asset benchmark

As investors, we look for the best performance. A good performance is not only an absolute figure, but also a relative one, when we make comparisons. For instance, if a share in our portfolio has a performance of 10% in a year, we can think that it is a nice number, in absolute terms. But if the reference index of the share has performed a 15%… well, it is not so nice. That is why it is interesting to take into account some figures to understand if our securities have a good quality compared with their benchmarks:

  • Relative trend of the security versus index: it compares both behaviours. If the figure is positive, the security is strong versus the index. If it is negative, there is a weakness. It is one sign to detect if our stock or fund is performing properly against the index.
  • Tracking error: this indicator measures the deviation of the difference in daily returns of the security and the benchmark. A higher figures shows that the daily returns of the security has a larger difference compared with the daily returns of the index.
  • R 2: it measures the similarity of the daily behaviour of both the asset and the index. If the figure is near to 1, there is a strong parallelism. If it is near 0, there is no relation.
  • Correlation: if R 2 measures the similarity of the behaviour, this provides more specific information. If the figure is near to 1, there is a positive correlation (both move identically in the same trend). If it is near to -1, the correlation is negative (both move identically in opposite trends). If it is near to 0, there is no correlation.

R 2 and correlation are very important to find assets not linked with the benchmark if its evolution is negative, for instance, when the index drops. On the other hand, it is also interesting to find correlated assets when the index soars.

  • Alpha and beta: both are quite important to measure the outperformance and volatility of the asset compared with the benchmark. We have an extended explanation in this post. Typical investor behaviour is looking for assets with good alpha.

Of course, the analysis of a single reference is not enough to get an idea about the relationship between the asset and the index. We have to look at all data and connect them to understand in a right way if we should put our money there or just go our quickly.

Alpha and beta: Greeks in my portfolio

Two main concepts in the modern portfolio theory are the alpha and beta measures. They give the investor some information about the asset (a share, a fund, an ETF, for instance) risk compared with its benchmark, but both are quite different.

alpha y beta in T-Advisor

f we take our T-Advisor screen and choose an asset (for this case, Vestas Wind System), the T-Report from it has a chapter titled “Relative performance vs index”. We already wrote about  correlation. Now, let’s explain what alpha and beta are and why they are important references for investors.

Alpha shows the outperformance of the asset compared to its benchmark for an assumed risk. In the picture, the figure is 0.0197. That means: this asset performs better than the reference index. The higher, the better. This additional performance has to do with other reasons not linked with the benchmark. This measure appears also for funds and portfolios. A way to discover if the fund manager is good is just looking the alpha.

What about beta? In this case, this figure measures the volatility or how much the asset varies in its price when the benchmark moves up or down 1%. If it is positive, the asset varies in the same direction as the benchmark. If it is negative, the variation is the opposite.

For instance, in the example above, beta is 1.27. This means that the asset is more volatile than the index: when the index changes 1%, the asset does 1.27%. If the ratio would be less than 1, that means that the asset has a low volatility.

This is the theory, but what about the practice? Just remember some ideas:

  1. Look for positives alphas but beware the beta together, because beta points how much risk you are accepting.
  2. For bullish markets, look for assets with high positive betas.
  3. On the contrary, for bearish markets, choose low or negatives betas. In this last case, the correlation is inverse.

In all cases, the investor is choosing the risk exposure. T-Advisor provides the figures. How much you are exposed is a question of your own decision.