Beta Return

There is an equation for calculating portfolio return. Where: In the equation for portfolio return, $\alpha$ is the alpha return, or nonsystemic risk, and $\beta$ is the beta return. Alpha return is an excess return of an investment over a benchmark or index. Beta return is the measure of the volatility of the return of an investment, creating an opportunity for a quick return or loss. Beta is a coefficient of variation (CV) between the benchmark and the volatility. Coefficient of variation is a measure of the dispersion of the data used in statistics. (${\text R}_{\text m}-{\text R}_{\text f}$) is the market risk premium, which is the risk of the portfolio compared to risk-free rates. Because the beta is multiplied by the market risk premium, a beta of one would mean the security's price moves with the changes in the market; the portfolio moved as expected. Therefore, a beta of less than one indicates that the security's volatility is less than the volatility of the overall market. Furthermore, a beta greater than one indicates that the security has volatility greater than the overall market's volatility. Mathematically, the portfolio return equation can be depicted as a straight line graphed with the excess over the portfolio on the y-axis and the excess over the market on the x-axis. An excess, or excess return, is a return that surpasses the riskless rate on a security. The beta is the slope of the line as the asset's value increases compared to the overall market. The beta is a measure of volatility because calculating it gives the standard deviation, the statistical measurement of the distribution or spread of a data set, between the portfolio and the overall market. The standard deviation of the market returns would measure the overall spread of the samples, or the data used, in the market. If the overall market has an average return of 12 percent and the individual points that make up that average have a wide range above and below this percentage, the standard deviation would be high, and therefore the volatility would be high as well. If the data points are all close to the 12 percent return, then the standard deviation is low, and the volatility is low. As a ratio, a beta of one would mean the portfolio and the market benchmark for the market as a whole have the same standard deviation. A beta of two would mean the portfolio is twice as volatile as the market.

A risk profile is an analytical evaluation of an investor's acceptance of risk. It is used to develop a portfolio with the best balance between risk and return, as not all investors have the same reactions to risk. The risk profile will match the investing style with the level and type of risk the investor is willing to tolerate. Alpha and beta risk can be looked at differently if they are taken as historical measures that are related to each other. Alpha is the historical deviation of the return of an asset and the expected return, and beta is the historical move of the asset away from the benchmark point. If an investor has stock, the beta is the risk that the stock's value will change compared to the overall market. The alpha tells the investor how well the investment manager is doing compared to the market benchmark.

Cash, fixed interest, property and international shares are all different investment options that have varying levels of risk associated with them. Cash, fixed interest and property are less risky investments than international shares due to many risks such as geo-political and tax that may be specific to a country. Thus, when there is low risk, the return may not be as high. With greater risk comes greater return, but the risk must be a calculated risk to achieve expected returns. Using these simplified definitions, risk is then a factor of the time that the asset will be held. However, while time will be a factor of risk there will always be other variables such as geo-political, tax, inflation, gross domestic product, and other economic or market and industry risks associated with any expected rate of return. Thus, if the investor must maintain relatively liquid assets, or assets that can be easily converted to cash, then the volatility associated with beta risk will be a problem.

For example, if Mary purchased shares in Big Systems Inc. at an above market price, and the shares then experience a rapid dip in price, Mary will not want to sell until the price increases so that there will not be any share, or profit loss. If she cannot tolerate loss, the stock will not be sold and will have a negative impact on Mary’s total portfolio meaning that any profit made with other equity or debt will be impacted due to the above price purchase of Big Systems Inc. stock. If she needs to make money, then alpha risk must account for volatility in order for the stock to make more money than can be gained by normal market movement. In this situation, the risk of low return is part of Mary’s risk profile.

Retirement investments are usually not within the same category due to age and need. This means that retirees are less inclined to take risks and are in greater need of liquid assets to assure they have enough cash, or cash equivalents, on hand to meet their needs. Thus, Mary’s needs will be different and when considering the concepts of alpha and beta risk age, need, and overall cash and investment needs must be considered to meet specific return criteria while always keeping in mind the risk factors and how varied risks can negatively impact returns.