Do low beta stocks/funds have any alpha?

[Saltynuts]

I think I remember reading some time ago that low beta stocks/funds actually tend to perform better on a risk adjusted basis than other stocks/funds. Their rationale for this phenomenon was that people want to get the most possible upside, but don't like to leverage, so they tend to buy riskier assets that give them more upside potential. But this pushes returns of those risker assets down vis-a-vis low beta stocks/funds. So the idea would be that you could buy more lower-beta funds/stock on leverage and get the same upside potential, but less downside potential. I think lol.

Does that sound right to anyone? If so, maybe an edge would be, in the money you are keeping off to the side because selling short straddles with 100% of your money would be, let's say, ambitious, you buy low-beta stocks/ETFs. Then maybe, just maybe, as the market crashes you sell those low beta ones and buy those higher-flying ones whose premium might well have turned into a discount.... and THAT sounds like some alpha right there ladies and gentlemen....

 

[believezz]

Beta is the return correlated with market and alpha is the unexplained difference in return (aka. uncorrelated component), so all stocks and funds have an alpha component except the market fund itself.

In theory, given two exact same stocks with different betas, higher beta stock is more attractive than the lower beta stock because it means free leverage. So arbitrage would force R(A) = R(B) + Risk free rate of the excess capital. So in theory the higher beta stock would trade at slight premium / has lower alpha.

Your strategy is essentially timing the market and increase beta exposure when it crashes, but I don't think that has anything to do with alpha. If you can offload beta before market crash and then rebuys at lower price then yes it's a (very) profitable strategy but that's no different to trading ES in hopes to beat the market with superior timing.

 

[Saltynuts]

Beta is the return correlated with market and alpha is the unexplained difference in return (aka. uncorrelated component), so all stocks and funds have an alpha component except the market fund itself.

In theory, given two exact same stocks with different betas, higher beta stock is more attractive than the lower beta stock because it means free leverage. So arbitrage would force R(A) = R(B) + Risk free rate of the excess capital. So in theory the higher beta stock would trade at slight premium / has lower alpha.

Your strategy is essentially timing the market and increase beta exposure when it crashes, but I don't think that has anything to do with alpha. If you can offload beta before market crash and then rebuys at lower price then yes it's a (very) profitable strategy but that's no different to trading ES in hopes to beat the market with superior timing.

But I'm asking if low beta stocks have more alpha than high beta stocks for the reason (I think) I read. Putting the market timing aspect aside (that's just me generating a little extra alpha on the side for you guys because I care), if these are the assumptions (just making up numbers here): Stock A has a beta of 1.4. Stock B has a beta of .7. So, without more, stock A should move twice what stock B moves (assuming that is the correct with how beta works). But if what I remember reading is correct, in good times stock will be priced higher than it should be on that higher beta because people prefer to get leverage as much as they can WITHOUT actually incurring leverage. So, assume a fair price for stock A might be $20, and a fair price for stock B might be $4 (again, made up numbers), what I remember reading said that the market price of A might be $21, and the market price of B might be $3.50, and hence its best to by more B and less A given that its expected future value is greater.

 

[Saltynuts]

But I'm asking if low beta stocks have more alpha than high beta stocks for the reason (I think) I read. Putting the market timing aspect aside (that's just me generating a little extra alpha on the side for you guys because I care), if these are the assumptions (just making up numbers here): Stock A has a beta of 1.4. Stock B has a beta of .7. So, without more, stock A should move twice what stock B moves (assuming that is the correct with how beta works). But if what I remember reading is correct, in good times stock will be priced higher than it should be on that higher beta because people prefer to get leverage as much as they can WITHOUT actually incurring leverage. So, assume a fair price for stock A might be $20, and a fair price for stock B might be $4 (again, made up numbers), what I remember reading said that the market price of A might be $21, and the market price of B might be $3.50, and hence its best to by more B and less A given that its expected future value is greater.

Maybe its the "more alpha" in my title and OP that is throwing you off. You might ask the question another way - do lower beta stocks have a better risk/reward ratio on average than higher beta stocks given that investors/traders prefer to get more leverage, but WITHOUT engaging in leverage themselves, hence they tend to bid up the high beta stocks less than the low beta stocks.

 

[believezz]

I answered in the second paragraph

In theory, given two exact same stocks with different betas, higher beta stock is more attractive than the lower beta stock because it means free leverage. So arbitrage would force R(A) = R(B) + Risk free rate of the excess capital. So in theory the higher beta stock would trade at slight premium / has lower alpha.

 

[Saltynuts]

I answered in the second paragraph

In theory, given two exact same stocks with different betas, higher beta stock is more attractive than the lower beta stock because it means free leverage. So arbitrage would force R(A) = R(B) + Risk free rate of the excess capital. So in theory the higher beta stock would trade at slight premium / has lower alpha.

I think I follow believezz. So your conclusion that the higher beta stock trades at a slight premium /has lower alpha - it that logical, or is that illogical? In the sense that someone is overpaying for the higher beta ones and underpaying for the lower beta ones? I mean, free leverage sounds great! Seems someone would pay for free leverage, and possibly rightly so, but I think the point of the article was people overdue it and pay too much for that leverage they don't want to leverage on their own. Thanks!!!

 

[believezz]

I think these are only generic theories, so they are logical and crucial to understand as they shape ones thinking approach. But to formulate precise strategies is something else.

And they're so small that it's almost negligible. So not really practical.

 

[ph1l]

It looks like they had alpha until last year.
https://www.robeco.com/media/3/1/1/...-investing-lost-its-mojo-us_tcm1010-27998.pdf
Has low volatility investing lost its mojo?

Here is one that says alpha is not a goal.
https://institutional.vanguard.com/web/c1/investments/product-details/fund/4419
U.S. Minimum Volatility ETF

• The fund’s objective is to achieve long-term capital appreciation with lower volatility than in the U.S. equities market. It can invest across the entire market-cap spectrum—large-, mid-, and small-cap stocks. The fund has no alpha, or excess return, objective. The advisor’s quantitative model uses a rules-based, active approach that considers stocks’ risk and diversification characteristics to create a portfolio with aggregate lower-volatility properties.

 

[sef88]

AQR wrote a paper on it

 

[Saltynuts]

I think these are only generic theories, so they are logical and crucial to understand as they shape ones thinking approach. But to formulate precise strategies is something else.

And they're so small that it's almost negligible. So not really practical.

But look at what ph1l cited below - those don't look particularly small and negligible, do they? Low beta going from +6% at highest point to like close to -3% at the lowest point (whatever those percentages represent)?