The Beta of a stock or portfolio is a number describing the correlated volatility in relation to the volatility of an index. By definition, the market itself has a beta of 1.0, and individual stocks are ranked according to how much they deviate from the macro market. A stock with a beta of 2 has returns that change, on average, by twice the magnitude of the overall market’s returns; when the market’s return falls or rises by 3%, the stock’s return will fall or rise (respectively) by 6% on average.
The problem with a single measure of beta during all market conditions is that it might understand/overstate the risk of a stock during bull/bear phases. For example, FINPIPE [stockquote]FINPIPE[/stockquote] has a fairly benign beta of 0.68. So you would expect it to hold up pretty well during volatile markets, correct? However, with a bear beta of 1.17, it is going to tank more than the broader market and with a bull beta of just 0.007, it is not going to rise as much as the market either. So you get all of the downside without the upside. ASHOKLEY [stockquote]ASHOKLEY[/stockquote], on the other hand, has positive asymmetry with a bear beta of 0.90 and a bull beta of 1.16.
The bigger question is can this asymmetry be converted into a model for generating stock picks? Can investing in a portfolio of stocks with bull betas > 1.2 and a bear betas < 0.8 result in meaningful out-performance? We looked all the way back to Jan 2010 to pick out stocks that met this condition to see if a portfolio of these names can outperform the market. It seemed pretty legitimate at first, who wouldn’t want to own stocks that didn’t fall as much as the market when it went down but rose more than the market when it went up?
The results were a bit of a disappointment. First, the stock picks were extremely sparse. There were only 5 days during the entire period where there were more than 5 stocks that met the criteria. So there just weren’t enough data points to confirm or refute the thesis. It also didn’t help that these portfolio did not outperform the market in any meaningful way.
The Bull Beta / Bear Beta thesis needs to be further tested for different bull/bear thresholds. It is an interesting thesis and we are big fans of repeatable, verifiable and systematic portfolio strategies. Stay tuned for updates!
