Using beta to assess alternative investment strategies
The term beta may not be immediately familiar to many investors but what it represents—an investment’s volatility relative to the overall market—is a concept that experienced investors understand well. We take a closer look at beta and how it may be used in assessing alternative investment strategies.
What does beta measure?
Beta measures the sensitivity of an investment to overall market movements and is effectively a measure of risk or volatility. Risk can be classified as systematic, affecting the whole market—such as macroeconomic, geopolitical, or systemic financial risks—or unsystematic, which are risks inherent in a particular sector, industry, or company. Beta measures the systematic risk of an investment, which provides insight into an investment's volatility relative to the overall market. The market is typically represented by a broad equity index, such as the S&P 500 Index with a beta of 1.0. An investment with a beta of 1.2 is 0.20 or 20% more volatile than the market. Similarly, a beta of 0.50 represents an investment with 0.50 or 50% less volatility than the S&P 500 Index.
What is good beta?
There is no good or bad beta. Appropriate beta for an investment depends on an investor’s objective. An investment with a beta of 1.0 may be appropriate for an investor aiming to replicate the broader market, while a beta below 1.0 may be appropriate when aiming to preserve capital. Similarly, a beta above 1.0 may be appropriate for a growth objective.
What are high and low beta stocks?
High beta stocks—those with beta above 1.0—exhibit more volatility than the broader market and are typically growth stocks, such as technology, energy, or small-cap stocks. Low beta stocks—those below 1.0—have less volatility than broad equity markets. These typically include value stocks in defensive sectors, such as utilities and consumer staples.
Does beta change over time?
Measures of risk in financial markets change as economic cycles and underlying factors change. An individual security’s beta relative to the overall market may change based on economic conditions and changes to a company’s business operations, leverage, profitability, competitiveness, and/or broader industry or sector changes.
How might beta be useful when assessing alternative investments?
Financial professionals often turn to correlation to assess the effects of adding alternative strategies to a portfolio. This is appropriate as combining low correlated strategies increases portfolio diversification. While correlation measures whether two assets are likely to move in the same direction, beta measures the potential magnitude of such moves. Using both measures in combination may help financial professionals gain more insight into an alternative strategy’s potential role within a portfolio.
For example, some alternative strategies have relatively high correlation to the S&P 500 Index, which means that they'll move up and down with the market's movements. Low beta combined with high correlation means that a strategy will move in the same direction as a broad market but won’t contribute the same level of returns to a portfolio and typically won’t experience the same magnitude of losses when markets fall. For instance, long/short equity has high correlation to the S&P 500 Index at 0.72 and low beta of 0.37. If equity markets gain 10.0%, long/short equity is expected to gain 3.7%. Similarly, if equity markets lose 10.0%, long/short is expected to lose only around 3.7%.
Correlation and beta of alternative strategies
5-year trailing through 4/30/24
Source: Bloomberg, April 2024. Past performance does not guarantee future results. See strategy and index definitions below. You cannot invest directly in an index.
Some alternatives—such as commodities, equity market neutral, global macro, and multistrategy—have low correlation and low beta compared to broad equity markets. This provides the potential for additional diversification and risk mitigation through low correlation and low volatility relative to equity markets. These strategies also exhibit low correlation to bonds, which indicates the potential for diversification of both equity and bond exposure.
How has this played out in practice?
We assessed the historical performance of several alternative strategies compared with the S&P 500 Index and Bloomberg U.S. Aggregate Bond Index during two key time periods to compare returns under different market conditions. First, during the extended late 2010s bull market, several alternative strategies delivered positive returns; however, the presence of low betas meant that returns weren’t as high as the S&P 500 Index. In 2022—a year of downturns for equities and bonds—the same low beta alternative strategies held up better than equities and bonds, providing crucial downside portfolio protection under difficult market conditions.
Comparative returns of stocks, bonds, and alternative strategies (%)
As a measure of systematic risk or volatility, beta is useful when assessing alternative investment strategies as part of a wider diversified portfolio. Used in combination with correlation, it gives financial professionals additional insight into the risk of an investment strategy and how it may complement other investments under different economic conditions. Importantly, there is no favorable or unfavorable measure of beta—each investor’s objective will determine the most appropriate level of risk that the investor should assume, and the strategies suited to achieving those objectives. Similar to correlation between different investments, beta isn’t a static measure. Many factors can affect the performance of an investment and asset classes over time, and both correlation and beta may change and should be regularly assessed to measure portfolio effectiveness.
Different types of alternative strategies can have meaningfully different risk/return characteristics. Find out more about investing in alternatives and whether they’re right for your clients.
Important disclosures
Alternative investments by their nature involve a substantial degree of risk, including the risk of total loss of an investor's capital. Further, alternative investments are subject to less regulation than other types of pooled investment vehicles, may be illiquid, and cannot assume that investments in the asset classes identified will be profitable or that decisions we make in the future will be profitable. Alternative investments may also involve significant use of leverage, making them substantially riskier than other investments.
Alternative investing involves substantial risk and there is an opportunity for significant losses. The products may not be suitable for all investors. Compared with a traditional mutual fund, an alternative fund typically holds more nontraditional investments and employs more complex trading strategies. Investors considering alternative mutual funds should be aware of their unique characteristics and risks. Alternative investments may also have limited performance information, low liquidity, and unproven strategies with unknown risks.
Diversification does not guarantee a profit or eliminate the risk of a loss.
U.S. large-cap equities are measured by the S&P 500 Index, which tracks the performance of 500 of the largest publicly traded companies in the United States. U.S. investment-grade bonds are represented by the Bloomberg U.S. Aggregate Bond Index, which tracks the performance of U.S. investment-grade bonds in government, asset-backed, and corporate debt markets. Market neutral is represented by the Credit Suisse Equity Market Neutral Hedge Fund Index, which tracks the aggregate performance of equity market neutral funds. Multistrategy is represented by the Credit Suisse Multi-Strategy Hedge Fund Index, which tracks the aggregate performance of multistrategy funds. Managed futures are represented by the Credit Suisse Managed Futures Hedge Fund Index, which tracks managed futures hedge funds. Global macro is represented by the Credit Suisse Global Macro Hedge Fund Index, which tracks global macro hedge funds, which may hold positions in practically any market with any instrument. Long/short equity is represented by the Credit Suisse Long/Short Equity Index, a subset of the Credit Suisse Hedge Fund Index, which tracks the aggregate performance of dedicated short bias funds. Global infrastructure is represented by the MSCI World Infrastructure Index, which tracks the global opportunity set of companies that are owners or operators of infrastructure assets. Commodities are represented by the S&P GSCI Total Return Index, which tracks general commodity price movements and inflation in the world economy. It is not possible to invest directly in an index. Past performance does not guarantee future results. Multistrategy is represented by Credit Suisse Multi-Strategy Hedge Fund Index, which tracks the aggregate performance of multistrategy funds. Real estate is represented by the iShares U.S. Real Estate ETF, which seeks to track the investment results of an index composed of U.S. equities in the real estate sector. It is not possible to invest directly in an index.
This material is for informational purposes only and is not intended to be, nor shall it be interpreted or construed as, a recommendation or providing advice, impartial or otherwise. John Hancock Investment Management and our representatives and affiliates may receive compensation derived from the sale of and/or from any investment made in our products and services.
The views presented are those of the author(s) and are subject to change. No forecasts are guaranteed. This commentary is provided for informational purposes only and is not an endorsement of any security, mutual fund, sector, or index. Past performance does not guarantee future results.
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