DEFINITION of High Beta Index
A high beta index is a basket of stocks that exhibit greater volatility than a broad market index like the S&P 500. The S&P 500 High Beta Index is the most well-known of these indexes. It tracks the performance of 100 S&P 500 companies that are most sensitive to changes in market returns. Beta by definition 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 (S&P) offers high beta variations of small-cap, mid-cap, and emerging markets to name a few.
BREAKING DOWN High Beta Index
A high beta index constituents exhibit greater sensitivity than the broad 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 and 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 like the S&P 500.
Gaining exposure to a high beta index requires an investment vehicle like an exchange traded fund (ETF). The PowerShares S&P 500 High Beta Index (SPHB) is the most widely traded asset that tracks volatile assets in the broader market. Since inception, the ETF has underperformed the underlying S&P 500 Index. In fact, the index posted double-digit declines in 2015 as the scare of a China slowdown and earning recession punished the entire stock market. The largest allocation in the fund comes from the financial and industrial sectors with some individual holdings like Advanced Micro Devices (AMD) and Arconic (ARNC).
Limitations of a High Beta Index
Contrary to popular belief, high beta or volatility doesn't necessarily translate to 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 broad 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 constraints behavioral biases like the representative heuristic and over confidence. In addition, sector selection and other fundamental criteria play an important role in the volatility and performance of a high beta index.