A:

Beta and R-squared are two related, but different, measures. A mutual fund with a high R-squared correlates highly with a benchmark. If the beta is also high, it may produce higher returns than the benchmark, particularly in bull markets. R-squared measures how closely each change in the price of an asset is correlated to a benchmark. Beta measures how large those price changes are in relation to a benchmark. Used together, R-squared and beta give investors a thorough picture of the performance of asset managers.

R-Squared Measures How Performance Matches a Benchmark

R-squared is a measure of the percentage of an asset or fund's performance as a result of a benchmark. It is reported as a number between 0 and 100. A hypothetical mutual fund with an R-squared of 0 has no correlation to its benchmark at all. A mutual fund with an R-squared of 100 matches the performance of its benchmark precisely.

Beta is a measure of a fund or asset's sensitivity to the correlated moves of a benchmark. A mutual fund with a beta of 1.0 is exactly as sensitive, or volatile, as its benchmark. A fund with a beta of 0.80 is 20% less sensitive or volatile, and a fund with a beta of 1.20 is 20% more sensitive or volatile.

Alpha is a third measure, which measures asset managers' ability to capture profit when a benchmark is also profiting. Alpha is reported as a number less than, equal to, or greater than 1.0. The higher a manager's alpha, the greater his or her ability to profit from moves in the underlying benchmark. Some top-performing hedge fund managers have achieved short-term alphas as high as 5 or more using the Standard & Poor's 500 Index as a benchmark.

The alpha and beta of assets with R-squared figures below 50 are thought to be unreliable because the assets are not correlated enough to make a worthwhile comparison. A low R-squared or beta does not necessarily make an investment a poor choice, it merely means its performance is statistically unrelated to its benchmark. (For related reading, see: Understanding Volatility Measurements.)

RELATED FAQS
  1. How do you calculate R-squared in Excel?

    Calculate R-squared in Microsoft Excel by creating two data ranges to correlate. Use the correlation formula to correlate ... Read Answer >>
  2. What's the difference between R-squared and adjusted R-squared?

    Learn how R-squared and adjusted R-squared values differ, how they are calculated, and the relationship between them. Read Answer >>
  3. What Is the Formula for Calculating Beta?

    Learn about beta, how to calculate it, and how it's used as a risk measure with examples that include Apple and Tesla. Read Answer >>
  4. How do you calculate beta in Excel?

    Learn how to calculate the beta of an investment using Microsoft Excel. Read Answer >>
  5. When is it better to use unlevered beta than levered beta?

    Understand what a security's unlevered beta and levered beta measure, and learn which one is more accurate in measuring a ... Read Answer >>
Related Articles
  1. Investing

    5 ways to measure mutual fund risk

    Statistical measures such as alpha and beta can help investors understand investment risk on mutual funds and how it relates to returns.
  2. Investing

    Understanding Volatility Measurements

    How do you choose a fund with an optimal risk-reward combination? Here we teach you about standard deviation, beta and more.
  3. Investing

    3 Cases When Beta Does Not Measure Volatility of Stocks

    Examine the theoretical and statistical relationship between beta and volatility to identify three factors that limit beta's explanatory value.
  4. Financial Advisor

    Does Your Investment Manager Measure Up?

    These key stats will reveal whether your advisor is a league leader or a benchwarmer.
  5. Investing

    Financial Ratios Every Investor Should Know

    Explore the risk metrics of mutual fund DODFX. Learn how beta, R-squared, capture ratios and standard deviation measure systematic and volatility risk.
  6. Investing

    Beta: Know the Risk

    Beta says something about measuring price risk in stocks, but how much does it say about fundamental risk factors too?
  7. Investing

    FKINX: A Risk Statistics Case Study

    Examine important risk metrics for mutual fund FKINX. Discover what beta, standard deviation and R-squared say about volatility and systematic risk.
  8. Investing

    Vanguard Mutual Fund With 65% Equity & 35% Bonds (VWELX)

    Explore several risk metrics of VWELX. Learn what beta, R-squared, capture ratios and standard deviation say about volatility and systematic risk for VWELX.
  9. Trading

    Bettering your portfolio with alpha and beta

    Increase your returns by creating the right balance of both these risk measures.
  10. Investing

    T Rowe Price Capital Appreciation Fund Risk Statistics Case Study (PRWCX)

    Analyze PRWCX using popular risk metrics that are part of modern portfolio theory (MPT). Explore PRWCX's volatility, correlation and return statistics.
RELATED TERMS
  1. Risk Measures

    Risk measures give investors an idea of the volatility of a fund ...
  2. Benchmark

    A benchmark is a standard against which the performance of a ...
  3. International Beta

    International beta (often known as "global beta") is a measure ...
  4. Risk Management

    Risk management occurs anytime an investor or fund manager analyzes ...
  5. Benchmark Error

    Benchmark error occurs when an inappropriate benchmark is used ...
  6. Zero-Beta Portfolio

    A zero-beta portfolio is constructed to have no systematic risk, ...
Hot Definitions
  1. Intrinsic Value

    Intrinsic value is the perceived or calculated value of a company, including tangible and intangible factors, and may differ ...
  2. Current Assets

    Current assets is a balance sheet account that represents the value of all assets that can reasonably expected to be converted ...
  3. Volatility

    Volatility measures how much the price of a security, derivative, or index fluctuates.
  4. Money Market

    The money market is a segment of the financial market in which financial instruments with high liquidity and very short maturities ...
  5. Cost of Debt

    Cost of debt is the effective rate that a company pays on its current debt as part of its capital structure.
  6. Depreciation

    Depreciation is an accounting method of allocating the cost of a tangible asset over its useful life and is used to account ...
Trading Center