Low beta stocks perform well during volatile markets, which we are likely to see in the existing landscape of Fed (talk of) tightening and heightened geopolitical instability.
The latter geopolitical instability could feature on investors’ radar in 2022, which could see capital flows into safe-haven assets.
Safehaven assets include precious metals, low beta stocks, and US treasuries. So heightened geopolitical instability increases institutional demand for US treasuries, which lowers the 10-year treasury yield and keeps the pressure of the Fed to raise the Fed fund rates.
A hawkish Fed can pivot to being Dovish and accommodating for longer by highlighting geopolitical instability, which becomes a face-saver.
We believe the Ukrainian Crisis is no coincidence.
Neither is it a coincidence that the UK’s war drums bang the loudest, the City of London is the third-largest holder of US treasuries globally. Only China and Japan hold more US debt.
China’s rising influence in the Pacific is rattling Japan, so both Asian nations are outbidding each other to influence the mediator, the US. When you own a nation’s debt, you influence its foreign policy.
The fictional movie, The Godfather, starring Marlon Brando, explains best why sovereign investors buy treasuries with negative real yields.
Staying with the plot, let’s define low beta stocks, which tend to protect investment portfolios in volatile times
Firstly, what is Beta?
So, the volatility of an asset or portfolio against a benchmark is called Beta.
The benchmark used is typically the broader market as measured by the S&P 500.
Low beta stocks are less volatile in a downward market or bear market.
In risk on environment low Beta stocks perform better
Have you noticed that sometimes when the indices are down in the red, some stocks are green, which is a sign of low Beta stock?
How can an investor calculate betas to determine whether a stock is a low Beta?
A beta of 1.0 means the stock moves equally with the S&P 500. So when the stock has a beta of 2.0, then stock moves twice as much as the S&P 500.
A beta of 0.0 means that the asset price action does not correlate with the index.
So a negative beta means price action moves in the opposite direction to the index.
In short, low beta stocks will outperform high beta stocks in a bear market.
What are the risks of holding beta stocks?
While low beta stocks have smaller price swings, they could still be in a long-term downtrend. So, adding a down-trending stock with a low beta decreases the risk in a portfolio, but the low risk does not mean any losses. An investor could still be exposed to potential unrealized losses if the stock is in a downtrend.
Another risk of holding low beta stocks is that when the market swings widely upwards from a sharp downtrend, these stocks underperform in a rising market
Nevertheless, low beta stocks have historically outperformed the market, and calculating the betas with fundamentals can help investors manage risk in the portfolio.
A long-term study from Harvard Business School analyzed stocks with the lowest 30% of Beta scores in the US against stocks with the highest 30% of Beta scores. The study concluded that low Beta stocks outperform by several percentage points annually.
Low beta stocks have offered a combination of low risk and high returns, according to the report
“In an efficient market, investors earn a higher return only to the extent that they bear higher risk.
Despite the intuitive appeal of a positive risk-return relationship, this pattern has been
surprisingly hard to find in the data, dating at least to Black (1972). For example, sorting stocks using measures of market beta or volatility shows just the opposite. Panel A of Figure 1 shows
that, from 1968 through 2012 in the US equity market, portfolios of low-risk stocks deliver on
the promise of lower risk as planned, but with surprisingly higher average returns. A dollar
invested in the lowest risk portfolio grew to $81.66, while a dollar invested in the highest risk
portfolio grew to only $9.76,” wrote the report.
Low beta stocks with high paying dividend yields are valuable in an investor’s portfolio, particularly in bouts of high volatility
The final note about classifying assets like safe-havens and beta stocks is that assets are dynamic.
Human intelligence compartmentalises complexities.
To an untrained eye, the electrical circuits in a fuse box or junction box look like a maze of wires, the engine of a machine appears messy, but a trained eye sees everything in compartments and systems.
Human intelligence subconsciously puts things into boxes and sub boxes, then breaks it all down into byte size logic which can easily be digested by the mind.
Faced with complexities and stress, human intelligence puts it all into boxes, which gives a false sense of safety.
So, in the world of investing, if the US dollar crashes, governments confiscate gold and nationalise utilities, how can these be safe-haven assets?
Beta stocks paying relatively high dividends are valuable. But unlike parts of a static machine, these assets are dynamic
Changing government policy, long technology waves of innovation, geopolitics, war can shatter the comfort of placing assets into boxes.