?Beta? is a measure of the co-variance of a company?s stock with the
broad market. As I?m sure you?re aware, we often use a broad market
index, like the Standard & Poor 500 or the Wilshire 5000 or the FTSE
as a market index.
What is it specifically? It?s the non-diversifiable risk of the
company ? which includes not just company-specific risk but also
Thus, if you wanted to enjoy the higher returns of a growing industry
such as semiconductors or Internet routers, you?d want a diversified
portfolio of many or all of the companies in that segment. You?d
likely end up with a higher beta of perhaps 2.0 ? but have diversified
the risks of individual companies and their product/market/financial
So, it?s true that a diversified portfolio with a beta of 2 is twice
as volatile as the market portfolio. A non-diversified portfolio (an
example would be just 2 semiconductor stocks) might temporarily have a
beta of 2 but returns would be dominated by company-specific risks of
one or the other of your stocks. Imagine, for example, holding only
Intel and LSI Logic stock ? then having Andy Grove defect to a new
startup semiconductor company. That?s the kind of firm-specific risk
that a non-diversified portfolio can?t handle.
?Beta Coefficient? (July 24, 2005)
A comment is probably necessary here: the confusion over ?diversified?
and ?non-diversified? is probably due to the difference between common
terminology and the statistical measurement.
A portfolio of semiconductor stocks would be thought by most to be
?undiversified.? Indeed, if you follow the search strategy below,
you'll see specific mutual funds referring to their investment
strategy as "concentrated" or "un-diversified," even though they may
be well-diversified within a sector (such as corporate bonds or
And for a broad market a semiconductor portfolio is "undiversified" ?
it will tend to have more U.S. stocks; it will have little in real
estate assets; it won?t correlate well with commodity pricing. A
recent (May 11) Wall Street Journal article talks about the
?most-diversified? portfolio and says that if you want to replicate
global markets MSCI Global Capital Markets says the ?optimal?
* U.S. stocks: 25.9%
* U.S. bonds: 21.1%
* Foreign stocks: 26.4%
* Foreign bonds: 26.6%
But from a statistical standpoint, a portfolio of semiconductor stocks
can be diversified. You?re trying to eliminate firm-specific risk,
while accepting the risk AND growth rate of the industry. Studies
show that with as few as 10 stocks, you can accomplish this.
Google search strategy:
diversified ?non-diversified? portfolio beta