Beta Stability: A New Persistent Factor?

The beta exposure of a stock is one of the first and most important statistics any investor looks at. Though perhaps simplistic, it distills a myriad of various properties of a stock into a single, easily digestible number. Using beta, it becomes easy to roughly forecast how an investor's portfolio would perform under different market conditions. Maybe out portfolio has a beta of 1.3 and we expect the market to return 11% next year: great, our portfolio should return around 14.3% (1.3*11%). While there's a lot of problems with this simplistic model, in this post, we're going to focus on just one: the beta of a stock changes significantly over time. Consider this graph of Apple's rolling, 252-day beta:

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The Value of Alternative Investments

A retail investor would be forgiven for assuming that there are really only two assets classes one should consider for personal investments: equities (stocks) and fixed income (bonds). Wherever you look, these two asset classes dominate the financial landscape. All robo-advisors and most personal advisors implement a mix of bonds and equities for the portfolios of their clients. The idea behind this mix is simple: bonds are low risk and will earn you a marginal return, while equities are riskier and will be the real engine of returns in good times. In bad times, bonds will rise, mitigating some of the losses of your equity portfolio: it's been long known and accepted that stocks and bonds have a negative correlation. Tying this strategy together is periodic rebalancing, taking money off the table during bull markets (and moving them to the safer bonds), and deploying money to the equity portion during bear markets. This in effect overlays a mean-reversion strategy onto the portfolio, boosting the returns of an otherwise static portfolio. The archetypal allocation is 60% equities, and 40% bonds, though each investor's allocation is going to differ based on his risk tolerance, age, and personal goals.

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The Low Beta Anomaly

Perhaps more than any other development, finance was ushered into the modern era with the development of the Capital Asset Pricing Model (CAPM) by William Sharpe in the early 60s. Though commonly criticized as too simple and reductionist, the model is still used today as an easy way to determine a stock's exposure to the market:

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