Alpha and beta: Taken together, these arcane investment terms drawn from the Greek alphabet can spell a sweet spot for mutual fund performance.

A lpha and beta: Taken together, these arcane investment terms drawn from the Greek alphabet can spell a sweet spot for mutual fund performance.

Alpha and beta are among the metrics analysts employ to interpret why funds have led or lagged market benchmarks in the past, and how they can be expected to behave under various market conditions.

Alpha is a measure of how well a fund has done compared with how it would have been expected to perform, given the risk of the market in which it was invested. Alpha can be positive or negative. The higher the positive alpha, the better the fund’s risk-adjusted return relative to its market benchmark.

Beta is a measure of how volatile a fund’s returns have been compared with its benchmark. A beta coefficient of 1.0 indicates a fund has market-level volatility, while funds with higher betas are more volatile.

The best of both worlds for a conservative equity investor is a fund whose portfolio manager has produced positive alpha, while maintaining a relatively low beta.

In evaluating high alphas and low betas, longer periods are more meaningful. Also, it makes sense to look at multiple periods. Any one period is subject to end-date bias, since a manager might have had a particularly good showing over that period. Investors should also be mindful of manager changes or changes in investment strategies during the period being measured.

Disclaimers aside, and for the sake of illustration, let’s look at alphas and betas for the 10 years ended Feb. 28 for Canadian equity funds.

Among 42 funds measured by Morningstar over that period, the vast majority have betas below that of the market. In fact, the only above-market scores belonged to Manulife Sector Rotation and iShares CDN Large-Cap 60 Index, whose betas of 1.02 were just a smidgen higher than that of the S&P/TSX composite index.

Cash held to pay for redemptions is one factor keeping funds’ volatility below that of the market. But stock selection surely had a lot to do with it, given the low levels of some fund betas.

The lowest 10-year beta scores, all in the 0.6 range, belonged to three funds managed by firms that serve mainly institutional clients:

Beutel Goodman Canadian Equity, managed by Beutel Goodman & Co. Ltd. a Toronto-based value-style firm known for taking profits as stocks reach target prices.

Mawer Canadian Equity, managed by Calgary-based Mawer Investment Management Ltd. Mawer seeks stocks with superior growth prospects that are trading below what is believed to be their intrinsic worth.

McLean Budden Equity Value, managed by a value-style team at McLean Budden Ltd. a Toronto firm that also offers growth-style mandates.

As these three funds showed, below-average betas need not mean below-average results. On the contrary, the Mawer fund’s alpha score ranked third-highest, with Beutel Goodman fourth and McLean Budden’s fund ranked seventh.

Coinciding with these favourable alpha and beta scores were superior returns. At the end of February, the 10-year annualized return of the McLean Budden fund was about 1.75 percentage points higher than the S&P/TSX’s 4.7 per cent.

Better still were the Beutel and Mawer returns of 9.4 per cent and 9.6 per cent respectively, double the index return. Alphas and betas may be telltale signs, but market-beating numbers speak eloquently in a language investors can appreciate.