According to the capital asset pricing model (CAPM), well-diversified investors only need to be compensated for the systematic risk of securities relative to the market. β measures the systematic risk of a security. As the portfolio held by the manager is not well diversified, β is not an accurate, reliable risk parameter.

Things to Remember

• Systematic risk is the risk that is inherent to the entire market or an entire market segment. It cannot be diversified away.
• Non-systematic risk, also known as idiosyncratic risk, is the risk that is specific to an individual security and can be diversified away by holding a diversified portfolio.
• The beta coefficient measures the sensitivity of a security's returns to the market returns. A beta of 1 indicates that the security's price will move with the market, while a beta greater than 1 indicates higher volatility and a beta less than 1 indicates lower volatility than the market.
• Well-diversified portfolios can reduce non-systematic risk through diversification, but systematic risk, as measured by beta, remains.