Most investors would already appreciate that the share market carries the most risk of the four major asset classes.
The overall level of risk an equity investor will be exposed to however, can vary dramatically from portfolio to portfolio.
One way to measure how risky a particular share might be is to look at its beta. In simple terms, beta measures how much a particular share price will move in comparison to the overall market.
Theoretically, a beta of less than 1 means that the shares will be less volatile than the market. A beta of greater than 1 indicates that the share price will be more volatile than the market.
An important point to note about a share's beta is that it does not take into account risks specific to a company or industry. This type of risk needs to be reduced by diversification.
Based on a share's beta, however, investors can begin to construct a portfolio that can be expected to be more or less defensive than the overall market.
Investors looking to protect their portfolios from excessive levels of volatility may therefore consider shares like:
Telstra Corporation Ltd (ASX: TLS)
It's hard for defensive investors to go past Australia's largest telecommunications company. Telstra has a beta of just 0.5 which means it is one of the least volatile shares on the ASX. The company generates a huge amount of free cash flow and this allows it to pay a generous dividend. This is one of the features that supports Telstra's share price during market downturns and investors can expect to receive a fully franked dividend of around 5.5% over the next 12 months.
Commonwealth Bank of Australia (ASX: CBA)
Although I am not a big advocate of owning any of the big four banks at the moment, the fact remains that a significant proportion of investors will still want some exposure to them. Based on its beta of 0.76, Commonwealth Bank is the least volatile of the big four banks and this sees its share price relatively well supported during periods of high volatility. Most investors have already caught on to this however, which means Commonwealth Bank is also the most expensive of the big four banks.
WAM Capital Limited (ASX: WAM)
Since its inception in 1999, the investment portfolio behind WAM Capital has delivered an average annual return of 17.8%. This is significantly higher than the broader market and this outperformance has been reflected in WAM Capital's share price over this time. Along with the benefit of capital gains and steadily increasing dividends, shareholders have also benefited from lower levels of volatility as measured by the stock's beta of 0.79. One important point investors should note, however, is that the shares are currently trading at a premium of more than 15% to the portfolio's net tangible assets. This is a significant premium and in a perfect world investors should look to buy the shares at or below the net tangible asset value.
Foolish takeaway
A stock's beta can be a useful tool to measure how volatile or risky a company is compared to the broader market and can help individuals to construct a portfolio that matches their risk profile.
