Quote from Ghost of Cutten:
Even assuming other things being equal (a false assumption in the real world, just look at the historical data for high beta stocks), the asymmetry only presents value if the price premium for the higher beta asset is lower than the asymmetry merits. If this were not that case then there would never be a case for owning low beta assets in favour of higher beta assets, and high beta assets would thus deserve an infinite premium over their lower beta cousins.
Historical data doesn't help much -- you don't buy "high beta stocks" as an asset class, you select for quality.
There are significant reasons why, say, higher beta small-cap value stocks have more embedded potential (if one knows how to dsicriminate) -- a large one being that institutional investors often face size and liquidity restrictions that keep them out of the higher beta small cap arena.
Re, case for owning lower beta assets: Dividend yields, safety, and size will always be arguments in favor (though again, you don't seek out these stocks as a class, or actually maybe you do if you passive index).
Futhermore, one can imagine a goal continuum: Maximization of compound gains at one end, preservation of capital at the other end. High beta vs low beta as a general rule tend to distribute across the poles, if you include dividend yields as a prime reason for investing in the low beta group. Then add into the mix that the higher risk of temporary capital impairment on the beta side (through volatility) can be mitigated through the application of skill.
All of this is nutshelled by Buffett (again) in his statement that he is confident he could make 50% per year managing smaller sums... he wouldn't do that buying sleepy names for 3% yields.
Quote from Ghost of Cutten:
As for the market factoring things in...ah, suddenly now you want to move away from theory into real world assumptions? Make you mind up! Either we're debating theory or the real world, you can't legitimately flip flop between them just to suit your argument. If stock A has beta 1 and stock B has a beta of 2, then you yourself admitted you would bid for stock B if everything else was the same, to take advantage of the free put offered by limited liability, and the greater upside. So, your own position claims that it's an obvious buy at that price - yet you claim the market won't recognise this? The onus is on you to prove that market participants would consistently make such an oversight. I don't see any reason they are more likely to underprice high beta 'leverage' than any other factor.
Market participants DO make such oversights for the reasons I just mentioned.
There is a class of stocks that tends to be higher beta in aggregate -- small cap value, stub stocks, spinoffs, OTC pink sheets etc -- that the institutional world deems "too small to mess with" for structural logistical reasons. This creates a powerful case for persistent higher returns in this area -- the field of competition is much reduced. (BUT not higher returns "in aggregate" -- rather higher returns in the best-in-class selection of opportunities from this group - the top decile let's say.)
Also as a general rule, the less followed the stock (in terms of analyst coverage etc), the greater the likelihood that something important may not be priced in / valued correctly, thus increasing profit potential. This tends to be a higher beta realm vs the stuff that the Fidelity manager buys for your Aunt Doreen's 401K.
Quote from Ghost of Cutten:
P.S. I was referring to permanent capital loss also - something which high beta stocks suffer more often than their low beta cousins.
Probably true in aggregate, but again I don't see much value in perceiving the world this way.
There are countless strategies out there, value and growth investing prominent among them, that come up somewhere between mediocre and terrible if you judge them by taking the skill out, e.g. trying to extrapolate across thousands of stocks. A truly skilled investor in the small cap value realm will be picking stocks with higher volatility in their share prices, but with real world odds of bankruptcy being near zero (because they are deliberately and obsessively focused on the underlying drivers and risks of the business).
Not coincidentally this is why so many academic studies wind up with bad conclusions; some egghead declares that "technical analysis doesn't work" because he ran a simulated version of a head and shoulders pattern across 5,000 instances over a 10 year period, taking zero account for vehicle selection, position sizing, environmental factors, and so on (skill-based inputs with no chance of being replicated).
