Portfolio Beta: What is Your Number and Why Should You Care?


John Micklitsch, CFA CAIA, President & Chief Investment Officer

According to Investopedia, beta is defined as “a measure of the volatility, or systematic risk, of a security or a portfolio in comparison to the entire market or a benchmark.” This definition, as usual, is a mouthful for most investors who are simply trying to understand certain aspects of risk in their portfolio. Although beta applies to both individual securities and portfolios, to simplify the concept for the purpose of this article, we are going to use the example of beta as it relates to an overall portfolio and are going to make the reference benchmark the S&P 500 Index or the “market” as it frequently is called.

Beta could be positive or negative and combines elements of return, volatility and direction. The directional aspect of beta is a function of whether the portfolio’s beta is positive or negative. A positive beta is associated with a tendency of the portfolio to move in the same direction as the market. A negative beta is associated with the expectation that a portfolio will move in the opposite direction of the market. A beta close to zero indicates the portfolio is not influenced by the market’s direction.

The magnitude of the portfolio’s expected move is measured relative to the market’s beta, which is set at +1.0. For example, a portfolio with an overall beta of +0.7 would be expected to earn 70% of the market’s return under normal circumstances. Portfolios, however, can also have betas greater than 1.0, such that a portfolio with a beta of +1.25 would be expected to earn 125% of the market’s return and so on. In this case, the 25% additional return is the compensation the investor expects to receive for holding riskier assets, which is where the volatility component of beta comes into play. In a down market, the portfolio with a beta of +0.7 would only be expected to be down 70% as much as the market. The portfolio with a +1.25 beta, however, would be expected to be down 125% of the market’s decline, an outcome that represents the other side of the coin for riskier portfolios.

In terms of how you calculate a portfolio’s beta, there are two primary ways. One is derived from the portfolio’s actual past returns relative to the assigned benchmark (e.g. S&P 500) and the other is calculated from the ground-up, security by security, on a weighted average beta basis. Typically speaking, equity-oriented assets have betas close to +1.0, core fixed income has beta close to 0.0, alternative investments can have lower but still positive betas and outright portfolio hedges, such as S&P 500 puts, have negative betas. Simply weighting the expected beta of the various securities in the portfolio will give you a rough estimate of the portfolio’s overall beta before taking into consideration any correlation benefit between asset classes.

The reason that knowing your portfolio’s approximate beta is so useful is that it gives you an estimate of the expected volatility of your portfolio during weaker market environments, such as the one we are currently experiencing. This is an important step in managing emotions during market selloffs. If an investor’s portfolio has a beta of +0.5, for example, and the market is down 10%, one could reasonably expect their portfolio to decline by 5%. Could you live with that? If the market was down 20%, that same portfolio could be expected to be down 10%. Could you live with that? If there is a point where you no longer feel comfortable with the expected portfolio downside, then adjustments can be made to the overall asset allocation to reduce beta, because trying to time market volatility is not a winning long-term strategy in our view.

With this knowledge in hand, if you have any general questions about beta or are interested in a specific conversation around beta and your portfolio, we would be happy to discuss further. Please feel free to reach out to your Ancora relationship manager and we will get it scheduled.

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