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.
High Beta Index Explained
High beta index companies exhibit greater sensitivity than the broader market. Sensitivity is measured by the beta of an individual stock. A beta of 1 indicates the asset moves in line with the market. Anything less than 1 represents an asset less volatile than the market, while greater than 1 suggests a more volatile asset.
For example, a beta of 1.2 means the asset is 20% more volatile than the market. Conversely, a beta of 0.70 is theoretically 30% less volatile than the market. Beta is measured against a widely followed index such as the S&P 500 Index.
Gaining exposure to a high beta index requires an investment vehicle such as an exchange traded fund (ETF). The Invesco S&P 500 High Beta ETF (SPHB) is a widely traded asset that tracks volatile assets in the broader market. The ETF has underperformed the underlying S&P 500 Index since its inception. In fact, the ETF is down 6.82% in the year through October 31, 2020, compared with a 2.77% rise for its benchmark. Financial companies constitute nearly 30% of the fund's assets, with Discover Financial Services (DFS), Lincoln National Corp (LNC) and Invesco (IVZ) among its largest holdings.
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.