Stocks for those who can embrace volatility

What are we looking for?

On Wednesday, we looked at the S&P/TSX Composite Low Volatility Index, one of the two new indexes based on the S&P/TSX composite that were unveiled last week by Standard & Poor's and the Toronto Stock Exchange. Today, we turn our attention to the other: the S&P/TSX Composite High Beta Index.

High-beta stocks are those that have the most sensitivity to market swings; they typically rise more than the broader market on up days, but fall further than the rest of the market on down days. While the Low Volatility index offers investors a calmer, more stable route through the Canadian stock market, the High Beta index gives them a way to supercharge their returns in bull markets – but with a greater downside risk.

Both new indexes have been licensed to PowerShares Canada – which, in all likelihood, plans to create exchange-traded funds based on them.

High beta

The S&P/TSX Composite High Beta Index is made up of the 50 S&P/TSX composite stocks with the highest beta measures – calculated by comparing the stocks' daily price changes over the past year with the daily price changes of the S&P/TSX composite. The 50 stocks are weighted by beta – the stock with the highest beta score carries the highest weighting. S&P will rebalance the index quarterly.

S&P and the TSX said the High Beta index "is designed to serve as a benchmark for investors with a bullish strategic or tactical view of the Canadian stock market." In other words, if you're convinced stocks are going up, this might be the index for you.

We don't have space here to show you the entire index, so we have produced a table of the 20 highest-beta stocks on the list.

What we found

The High Beta list is dominated by traditionally cyclical sectors – mostly mining stocks. These sectors are historically the most sensitive to changes in economic momentum, a key contributor to market sentiment and growth prospects.

In its back-testing of the High Beta index, S&P found huge outperformance in years when the overall stock market rallied – and big underperformance in years when the overall market fell. In the bear market of 2008, for instance, the High Beta index tumbled 63 per cent on a total-return basis, almost double the 33-per-cent decline of the S&P/TSX composite. But in the recovery year of 2009, total returns on the High Beta index were a stunning 109 per cent – far exceeding the S&P/TSX composite total returns of 35 per cent.