Quick Take: Beta Compression During Crises

Authored by

  • Mark Birmingham, CFA

    SVP, Lead Portfolio Manager, Managed Volatility

  • Michele Goe, Ph.D.

    AVP, Analyst, Research

Beta compression during the Lehman sell-off…

  • When market participants sell indiscriminately, stocks don’t necessarily behave as their betas would predict. In particular, lower beta stocks may underperform what their betas would imply. It’s not surprising to see this “beta compression” when markets fall sharply.

  • In the month following the 2008 Lehman Brothers bankruptcy, for example, DM low volatility benchmarks outperformed cap-weighted indexes (MSCI World down more than 20%) but underperformed their long-term betas.

  • As investors rotated into more defensive stocks, low beta performance came back into line with long-term expectations; downside protection of low volatility portfolios stabilized and then improved for the remainder of the crisis.

… and coronavirus

  • As MSCI World fell more than 10% after news that COVID-19 was spreading beyond Asia, low volatility benchmarks again underperformed their historically estimated betas.

  • Low beta DM stocks recovered relative to their long-term beta informed expectations during the snap-back rally in early March. In this case, defensive stocks enjoyed gains similar to cyclicals, perhaps due to the continuing decline in yields.

  • As a result we have seen the downside protection of DM low volatility portfolios recover – more quickly than during the initial stages of the 2008 GFC. 

Low Beta DM Returns during Two Crises

Beta Compression During Crises Figure 1
Beta Compression During Crises Figure 2
* “Low Beta Implied” reflects the return on portfolios based on their historically-estimated betas to MSCI World and MSCI World’s realized return. Hypothetical high and low beta portfolios reflect high and low beta quintiles (equal capitalization), with stocks’ weights derived from MSCI World Index. Sources: Acadian calculations, MSCI. MSCI data copyright 2020. All Rights Reserved. Unpublished. Proprietary to MSCI. For illustrative purposes only. Results do not reflect transaction costs or other implementation frictions. It is not possible to invest directly in any index. Every Investment program has the opportunity for losses as well as profits. Past results are not indicative of future results.

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