Why Beta Is Bunk as a Fund Measurement

As you can see, the majority of the plots, which represent certain mutual funds, fall well below or above the "expectations line." Had the beta coefficients more accurately predicted the relative performance, the majority of the dots on the graph would cluster along that line.

We computed an "expected" return for each of the funds on the basis of its April 2004 beta coefficient and then calculated the difference -- as measured in percentage points of three-year total returns -- between the beta coefficient and the funds' subsequent returns. We identified the funds that most exceeded their expected returns and those that lagged by the most percentage points.

The beta coefficient is considered a measure of "market risk" by many analysts. Therefore, a tendency to exceed the return indicated by a fund's beta coefficient can be described as a "risk-adjusted" return.

For example, the beta coefficient of 0.80 for the Fidelity (FDEQX Quote)Disciplined Equity Fund (FDEQX) indicated that it should have advanced less than the S&P's 12.24% annual rate over the past three years. But it surpassed its "expected" return of 10.49% by a whopping 4.87 percentage points per year.

Similarly the Fidelity (FTXMX Quote)Tax Managed Stock Fund FTXMX), with a beta of 1.04, would have been expected to perform slightly better than the S&P -- at an annual rate of 12.59%. Instead, it roared ahead at an annual pace of 16.71%.

On the other hand, the T. Rowe Price (PTEGX Quote)Tax Efficient Growth Fund (PTEGX), with a beta of 1.06, was expected to outpace the annual growth of the S&P and return 12.77% annually. Its actual annual total return of 6.73% was barely half the growth rate predicted by its beta coefficient.

An even greater shortfall, vis-a-vis its beta-generated expectations, was suffered by the American Century (TWCIX Quote)Select Investment Fund (TWCIX). The fund's expected return, according to its April 2004 beta of 0.86, was 11.02% annually. The actual annual rate of gain for the three years was a sluggish 4.38%.