While analyzing investments, investors use a variety of financial measures. Before purchasing a security, it is vital to have a good understanding of the potential of an investment.
The beta parameter, used in fundamental analysis, is one of the most extensively used metrics.
Amongst the essential financial measurements, you’ve probably never heard of is beta. This article will explain beta in ETFs and how it affects your exchange-traded funds.
First and foremost, it is important to learn more about beta and how it affects stocks and ETFs.
The statistical metric beta is often used to analyze investments. It examines a stock’s sensitivity to the larger market, which is commonly quantified by an index such as the Nasdaq 100, S&P 500, etc.
The Direxion Nasdaq 100 Equal Weighted Index (QQQE) is one ETF that tracks the Nasdaq 100 Index.
Beta measures just how much security is likely to go up or down daily concerning the tracking Index. It is, in essence, a measure of a security market or systemic risk.
A stock with beta 1.0 swings in lockstep with the general market, that is, a 1% increase or decrease in the underlying index, in our case, the Nasdaq 100, is mirrored by a 1% gain or fall in the company’s price.
Let us look at it with the help of a simple hypothetical illustration
As you can see, QQQE tracks the Nasdaq 100 perfectly, leaving the tracking error behind. The ETF perfectly mirrors the changes in the Nasdaq 100. However, this is not the case always. In our example, the beta is 1.
The lower the beta, the less susceptible the underlying instrument is to the market. The QQQE has a beta of 1.04, according to ETF.com, suggesting that if the Nasdaq 100 rises by 1%, the ETF will climb by 1.04 percent. This is because the ETF’s fundamental driver composition differs from the index, it has a differing beta value.
According to Yahoo Finance, the Aberdeen Standard Physical Gold Shares ETF (SGOL) has a beta of 0.08, which means that if the S&P 500 rises 1%, the gold ETF will advance only 0.08 percent.
Since the ETF’s fundamental drivers differ from stock ETFs, it has a lower beta value.
As a result, putting together an investment portfolio with composite or blended beta value can be an effective risk management strategy. If the equity markets fall, an investor can place himself with downside protection with a beta of 0.08, the Global Beta Low Beta ETF,
For example, has low market fluctuations than the S&P 500 because the index is re-weighted on a revenue basis and is designed to reflect the results of components from the S&P 500 with a minor beta comparable to the S&P 500.
GBA restricts each index element at 5% through quarterly rebalancing to mitigate concentration risk at the issuer level. Similarly, fixed-income ETFs have lower beta values than stock ETFs since bonds are less volatile than equities.
A bond ETF that invests in investment-grade bonds is the iShares Core U.S. Aggregate Bond ETF (AGG). It has a low beta, implying it is not affected much by market fluctuations.
Investors might also look for volatile ETFs with elevated amounts of market-related volatility. The SPDR S&P Emerging Markets Small Cap ETF, for example, invests in small-capitalization shares in emerging markets. This ETF has a higher beta value.
In financial analysis, beta can be a precious instrument. Depending on the investor’s risk tolerance, statistics can assist in determining which stocks are generally steady and low or more volatile.
Investors who are risk-averse and would not want to be subject to higher risks (such as pensioners) should tend to favor ETFs with lower beta values in their portfolios.
Younger investors with a broader investing horizon, on the other hand, may prefer to own ETFs with greater beta values. Those ETFs are likely to have a higher risk-reward profile, making them a good option for youthful investors who have the luxury of time to ride out any losses.
FAQs
What is an ETF?
An ETF stands for exchange-traded fund (ETF). One single ETF is a basket of securities that can be bought and sold like mutual funds through a brokerage firm. ETFs track a specific index such as S&P, sector, commodity, or other assets. Much like stocks, ETFs can be traded on the market.
Is an ETF better than a stock?
Investing in an ETF is less risky than investing in a stock, as ETFs are diversified. In the case of ETFs, investors do not control what happens to the portions of the ETFs.
ETFs have a diversified profile of assets, and the risk associated with the investment is reduced significantly. In stocks, the risk attached is higher as the stock price depends entirely upon the company’s performance and other exogenous factors of the world.
