Feb

14

Here's a little more commentary on the issue of high vs. low beta stocks, to be appended to these links:

Link1

Link2

Link3

In those links I argued that the apparent under-performance of high beta stocks is illusory, and that the current popularity of low-volatility stock strategies is unjustified. High beta stocks have actually done fine over the past dozen years or so in terms of their appropriately risk-adjusted performance as measured by "alpha".

For a little more insight, I plot below the compound total return of $1 invested in the S&P 500 index ETF, ticker SPY, along with the return of $1 invested using a margin account, with a leverage of 2 to 1. The margin account position is re-adjusted to 2 to 1 at the end of each calendar month, and interest is charged to the account at the rate of the 3-month t-bill rate (which is significantly less than what a real investor would have to pay).

The 2-1 margin account is the true benchmark for a portfolio of beta=2 stocks, and we see that the 2-1 margin account did poorly over the full period, turning $1 into $0.96, with much undesirable sound and fury, while the unlevered SPY turned $1 into $1.36. Any real-world margin account would have to pay more than the t-bill rate — a reasonable guess is 2% more per year, which would have further degraded the leveraged account.

So if your high beta stocks seem to have done poorly over the past 12 years, much or all of that is due the market itself and their heavy exposure to it.

That could all be different over the next 12 years, and if you're the type who wants 2-1 exposure to the market, there's no evidence to suggest that an un-levered portfolio of beta=2 stocks is a bad way to get it.

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