Today we’re going to discuss a key trend in the Beta factor that has heavily impacted investor portfolios during the turbulence of the past few weeks. This is the dominant factor to keep an eye on as we’re seeing significant polarization in company exposure to Beta, resulting in a phenomenon that has hurt investors as the market both falls and rises. We’ll elaborate further on “Runaway Beta,” including some data that can help provide historical context, and discuss ways to immunize your portfolio against it. We’ll also provide our weekly market and factor update.
As a reminder, the factor return is based on a portfolio that is long high Beta stocks and short low Beta stocks — so this chart tells us that higher Beta stocks are vastly underperforming lower Beta stocks. The reasons for this are several, including the fact that high beta names usually have more risk associated with them, and thus get punished in a risk-off environment. Higher beta names also typically have more growth expectations baked into their price, so when global growth is likely to swing negative, the short term expectations for these names get crushed.
Here we see the depths to which Beta factor returns plumbed during the GFC, which is the closest comp to our current market decline. Something we’d note is that because Beta return has fallen at a sharper rate than it did during the GFC so far, it’s possible that it may also recover at a quicker rate from trough than it did back then, as well. This recovery may also be amplified by the broader global usage of the internet and social media in the event that good news about the virus (a vaccine, effective treatment, etc) of the virus is announced.
When a crisis hits and certain industries and countries are hit harder than others, Runaway Beta can quickly hit any asset. For example, funds that hold retail and travel names will see Beta creep (more like a sprint) to unprecedented levels. To illustrate this point, let’s take a look at a couple of of stocks that have exhibited this dynamic from both ends of the spectrum.
This is CAR’s Beta exposure during that same time. It’s evident that as the stock price dropped faster than the market, Beta exposure popped from +1.18 on Feb 11 to +3.15 on Mar 12, after hitting a peak of +3.45 on Mar 6th.
Every single day, names like this are taking on additional Beta exposure, which continues to build as the market falls, effectively creating an Ouroboros of Beta.
From a Beta perspective, GILD had already started the period underweight the factor with an exposure of -0.35 exposure. Today, it sits at a much lower -2.01.
What we’ve attempted to show here is the extremity of the dispersion of predicted Beta and Beta exposure in today’s market environment. This polarization of Beta can lead to more unintended risks and massive swings in your portfolio, regardless of your portfolio positioning. In the hedge fund world, we’ve seen this play out this month as a lot of firms have experienced the double whammy of losing money as the market moves in either direction. Using the GFC as an analog, it’s clear that we neither want to be long Beta on the way down, or short on the way back up.
While we hope this disruption to the global markets, economy, and way of life is as short-lived as possible, it’s safe to assume that volatility will continue to envelop our screens for the foreseeable future. We are here to help, so please feel free to reach out to me at any time to discuss any of the above, and use us as a resource early and often.
US & Global Market Summary
US Market: 3/06/20 - 3/12/20
Factor Update: Axioma US Equity Risk Model (AX-US4)
Factor Update: Axioma Worldwide Equity Risk Model (AX-WW4)
Please let us know if you’d like to discuss runaway Beta in more detail and would like to learn how we can help you reduce your exposure to it.