Understanding portfolio beta

What is your portfolio’s beta? Even if you aren’t aware of your portfolio’s beta, you must be knowing if it is below 1 or above 1. Well, if you do not know your portfolio’s beta then you should immediately check it.
What exactly is this highly statistical term – “Beta” ?

Definition

Beta is a measure of systematic risk. Systematic risk, also known as the market risk, is the risk inherent to the entire market and thus it is not diversifiable.

What does it show?

Well, Beta shows you the tendency of a stock’s returns to the general market swings. It goes like ~ How much does a stock move in response to a 10% movement in the market?
If the market falls by 10% and a stock falls by 5% in that period, then it’s BETA is 0.5 (Roughly). The formula for beta is given by:
You don’t have to dive into statistics to know beta. Beta for most stocks is available on the internet and is a click away!

Portfolio Beta

A portfolio which has a single stock has a beta equal to the beta of that stock. A portfolio of more than one stock has a beta equal to the weighted average beta of all stocks. The portfolio beta shows you the returns of the portfolio against the swings in the market. Let’s assume that your portfolio has a beta of 1.5, what does this mean?
This means that a 10% rise in the general market is expected to trigger a 15% rise in your portfolio (Roughly).
You can use a simple excel sheet to keep a tab of your portfolio’s beta.

How to use the portfolio beta?

Portfolio beta can be extremely useful for long term investors to protect downside and generate returns. If you, as an investor, feel that the markets are near a top or at stretched valuations then you can go for a low beta portfolio (Less than 1). When the market corrects, your portfolio will fall lesser than the market.
Similarly, if you feel that the markets will rally sharply then you can go for a high beta portfolio. In this way, your portfolio will rise faster than the market.

Low beta stocks have outperformed high beta stocks in the long run as proven by many studies globally. You can find many interesting research papers on this topic from Harvard, NYU-Stern and other university papers.

Does beta matter?

If you are a serious investor and want to make high returns sustained over a long period of time, then you cannot afford to overlook portfolio beta!
We at Raghav Behani Equity Research place a lot of emphasis on beta while creating portfolios. There are two pars to our advisory services:
i) Selecting the right stocks
ii) Making the right portfolio allocation for that stock
The allocation of different stocks in our portfolio varies from 2% to 14% of the portfolio. And this has helped us generate very high risk-adjusted-returns for our clients over the last few years! We adjust the portfolio beta using the right asset allocation techniques.

The beta of our portfolio is less than 0.9 and we have outperformed the Nifty by a huge margin. Our latest portfolio details are here: Q1FY18 Performance

Some investors are of the view that a Beta of 2 can be used as a leverage for better returns. As in, you construct a portfolio with a beta of 2 and use this for generating higher than market returns. However, studies show that a Beta of 0.5 can outperform the portfolio with a beta of 2. Investors should study their portfolio beta regularly, just like they study the quarterly announcements of the companies that they invest in.

How to protect your portfolio from market crashes? Read here: Crash Proof Portfolio

Cash – Good for portfolio?

When in a bull market, the returns are coming in so fast that investors hate idle cash the most. They see cash as a loss of returns, an opportunity cost. So much for not wanting cash in portfolio, they even start leveraging! That is borrow and invest. The euphoria of a bull market usually means extreme and absurd valuations. These valuations are usually justified in the name of growth, PEG, economy boom, etc. There hardly is any scope left for long term investments! Even coal sells at the price of a diamond with the justification that it is a future diamond.
When in a bear market, it is dull, the investors have run away after the crash, every share is hammered and beaten down. Even the diamonds sell at the price of coal, without any justification. Investors are out of cash since the crash has evaporated their portfolio and leverage has made them pay out of their pockets!
 

So, is cash important?

Mr. Cool and Mr. Furious are 2 individuals who work in a private bank. Both started to invest in equities in 2003 with Rs. 2 Lakhs. By July, 2007 their portfolio had grown to Rs. 6 Lakhs, thanks to the bull run.
 
Mr. Cool and Mr. Furious catch up for coffee and reflect upon their portfolio. Both are happy!
 
Cool – It has been a great year buddy, the markets have soared to record highs.
 
Furious – I agree. But you know what, this is just the start! My broker says Nifty will double from here too!
 
Cool – Looks tough, it is already at a P/E of 25.. We must reduce our equity exposure and start parking funds in bonds.
 
Furious – Are you mad? What do bonds give? 6% p.a? I will get that every week. I am infact planning to borrow another Rs. 4 Lakhs and invest to double money fast.
Cool – Hey look, the bull markets are always followed by a crash and you can invest in good stocks when valuations fall. The valuations are not at all justified now.

But Mr. Furious has other plans. He borrows Rs. 4 Lakhs and thus now has an exposure of Rs. 10 Lakhs in equities. 3 months later, the markets have soared by 25%. The friends meet again.

Furious – Whats up brother! My portfolio has touched Rs. 15 Lakhs, I am loving this! How is your portfolio performing?
 
 
Cool – Well, I have just sold out my entire portfolio and have parked the funds in bonds. These valuations won’t sustain.

6 months later, the markets have crashed by 50%. Mr Furious is upset as his over-leveraged portfolio has fared worse than the market. He has lost 80% of his money in stocks. His portfolio is worth Rs. 3 Lakhs now and he has to repay a loan of Rs. 4 Lakhs + Interest. The friends meet again.

 
Cool – Well, I didn’t expect it to be so fast! Hows it gone for you?
 
Furious – My portfolio is worth Rs. 3 Lakhs and I have to repay a loan of Rs. 4 Lakhs plus interest of 15%, planning to sell off my holdings. I am done with the stock markets, it is purely insider news run with the operators. It’s not for small investors like us.
 
Cool – Well, I don’t think so. Infact I am planning to start shopping now. There are stocks like Page, Eicher, Mayur which seem good and are at cheap valuations.
 
Furious – Even if I want to invest now, I have no money. And they say that the markets will crash even more. Better stay away from stocks!
 
Cool – There might be blood on the street for now but these valuations will never come back again.

See the difference between the situations of both of them! At this point everyone wants to be “Cool” but noone would have the guts back then to take this decision. 10 years later, lets see what has happened.

 
Furious – Nice house friend, where did you get the funds from?
 
Cool – My stocks have become huge multibaggers! An investment of Rs. 6.5 Lakhs back then in 3-4 good stocks has given me Rs. 2 Crores now!
 
Furious – Wow. All I am now getting is 5% p.a. on my FD’s. Wish I too had shifted to cash at that time.


This story, though imaginary reflects the truth about stock markets. At the peak of a bull market greed blinds all rationalism and the bottom of a bear market fear grips the minds. One secret to make a fortune out of investing is to be ready when opportunities strike. Having cash in hand at the right time is necessary for this. For example, Nifty is at a P/E of 25 now, how much cash should you be holding? Also, which debt funds to select for the portfolio? The answer would differ from person to person.

Crashproof Portfolio: 4 Ideas

A stock market crash is every investors nightmare. Seeing your portfolio erase all gains and slip into losses can be a real test of patience. So how do you protect your portfolio from a crash?
The business world is full of uncertainties and noone can really predict the reason or source of the next market crash. Ups and downs are a part of investing in the stock market and you need patience and conviction to sail through the bad times. No matter how good the companies are in your portfolio, the share prices of these companies will not be immune to short term market volatility. There are steps you can take to protect your portfolio from market crashes and in this article we shall discuss some of them. However, before proceeding, we have a small checklist for you.
i) Know your portfolio’s beta:

Beta is the correlation between your portfolio and the index. Let’s assume that for every 1% movement in the Nifty, your portfolio value moves by 1.5% then it indicates that your portfolios beta is 1.5; To compute your portfolios beta, you need to multiply the beta of every stock by its weightage in the portfolio.In the above example, the beta of the portfolio is 1.71 and the total value of the portfolio is Rs 20 Lakhs at current prices.
ii) Know your portfolio’s allocation:
Are cash and cash equivalents 10% of your portfolio or 25%? How much do debt funds make up in your portfolio? Maintain a tracker to stay abreast with your asset allocation.
Now, lets discuss the steps to protect your portfolio from market crashes.

1. Hedging with Futures and Options

The beta of your portfolio is 1.71 and the value is Rs 20 Lakhs. So to create a complete hedge, you need to short Nifty futures worth Rs 34.2 Lakhs. If you are confident that the market WILL crash then you can use this method to hedge. The losses in your equity portfolio will be offset by gains in the Nifty futures short.
Hedging with options is another alternative at your disposal. You can write call options or buy put options to protect from the downside. Beware of buying puts as a hedge because there are many research papers which show that the cost of “insuring” your portfolio will lead to long term under-performance.
Ideal for: HNI Investors
Knowledge of derivatives is required.

2. Asset Allocation

This is our preferred way under our investment advisory services. The reason is that it requires no pin-point timing and it suits retail investors.
If you feel that the markets are trading at stretched valuations and that a correction is long due, you can reduce the exposure of equities in your portfolio. In the above example, the portfolio has a 100% exposure to equities. As an investor, you can reduce this exposure by selling shares and holding cash in the portfolio.
In the above table, you can see that the portfolio’s beta has reduce to 0.86 and cash is now 50% of the portfolio. So if the market falls by 20%, the portfolio will fall by 16% to 17% as opposed to 34% it would have fallen without cash. However, the downside is that incase the market keeps going up then you will lose out on potential gains.
Debt Funds are a great way to hold cash. They yield you close to 8.5% to 9% p.a. with very low risk and can help offset portfolio drawdowns. However, if you choose the wrong debt funds you will actually end up losing money! 1% earned less is debt funds is better than going for higher risk higher return.
We use statistical models to decide which debts funds to recommend to our clients. As per the client’s risk profile, we select the debt-equity allocation for the portfolio which ranges from 90:10 (Equity : Debt) to 40:60 (Equity : Debt). The portfolio of a 25 year old and a 55 year old will differ significantly right?
Ideal for: HNI Investors and retail investors
Regular tracking of fundamental factors is required.

3. Monthly SIP

If you have a steady source of income and also have a fair understanding of stocks, you can make monthly investments in your equity portfolio. This will help you average out the cost of your shares as you keep investing when prices are falling lower and lower. However, it is strongly recommended that you read this article before making an SIP in direct equities – First Steps of Investing
Under our investment advisory services we give a monthly guidance report to our clients on their SIP investments in equities.
Ideal for: Retail investors

4. Invest in Low-Beta Equities

While it is true that low-beta equities cannot give you 4x-5x in a year, it is observed that low-beta equities go down slower than the market and recover faster later. That is why they outperform the market on a longer timeframe. Most of the low beta equities are high quality companies with strong moats. Names like Nestle, HDFC Bank, Honeywell, etc are few names from the Indian markets with such characteristics.
Ideal for: Informed investors

First Steps of Investing

This article contains extracts from Raghav Behani’s book First Steps of Investing which is available on Amazon for Rs 99. Click here to buy

The fact that you are reading this article shows that you are interested in financially securing your future. Learning and reading are the gateways to new horizons. By the end of this article, some of your confusion will be gone away and you will surely have a direction to work in.
Assume, you need to make a football team (Portfolio). Would you buy 11 strikers (Smallcap stocks) and no defenders (Debt funds, PF , etc)? In a rare case you could win that game but a well organised team (Inflation, market risk) will definitely beat you! For making a well balanced team, we will need:
  • Goal Keeper (Insurance) – Defending our family
  • Defenders (Fixed Income) – Protecting during bad times
  • Midfielders (SIP in Mutual Funds) – Creating opportunities
  • Equities (Direct stocks) – Generating superior returns
Striking a perfect balance will give us an all-weather team (portfolio). Something like this:
Now lets go into the details:

Term Insurance (Goal Keeper)

You need a term cover that is around 15x to 20x your annual income. Suppose your annual income is Rs 12 Lakhs a year. Then you need a life cover of atleast Rs 1.8 Crores to Rs 2.4 Crores. In case you die, your family will have a lumpsum of Rs 2 Crores (Average) which they can put in an FD and get Rs 1 Lakh a month to keep their standard of living intact!
This varies from individual to individual. A person earning a salary and business income but also having good rental income, other investments might need a lower multiple of term cover. The benefit of going for a term plan early is that premium is low and fixed for the entire period of the cover. (Drop in an email to raghav@dalalstreetbulls.com for term cover consultancy).
Don’t mix insurance and investments. LIC and all other plans your agent sold you will have meager cover which will be inadequate for your family’s protection. Don’t let your policy lapse but rather complete the premiums and move it to a better investment avenue.

Emergency (Defenders)


Now you need to protect yourself from temporary turbulence that come up in life. Medical needs of family, liquidity crunch due to professional reasons, repairs to car and home, etc. Unless your astrologer can pin-point predict the date of these emergencies, you will need to be ready 24×7 for these!
6 months household expenses in a liquid fund, medical and health insurance, car insurance etc are very much needed. The quantum again depends from person to person.

Mutual Fund SIP (Midfielder)


We all like the thrill of trading/investing in equities. That moment we hit a classic trade or investment makes us feel like a champion! A master of this universe and what not! But lets accept it. We are so busy in our career that we don’t have the time and resources to make informed investment decisions in equities.
Do an SIP in good mutual funds – Equities, balanced or debt will depend on your risk profile and other factors. SIPs in mutual funds ensure that we stay disciplined because when it comes to equity portfolios, investors are unable to invest with a vision and end up losing whatever profits they make due to greed and fear.
Did you know:
An SIP of Rs 5000 per month for 35 years can leave you with Rs 7.5 Crores. All you need is a 15% p.a. CAGR

Stocks (Attackers)


Our portfolios need that alpha which direct investing in equities can generate. With proper research and guidance, we can definitely generate 22% p.a and higher in the long run. If invested with a vision, not only will you make profits from the stock market but more importantly you will also re-deploy those profits in more profitable avenues to compound your portfolio to double it every 3 to 3.5 years. If you just do a random walk in the park with your equity portfolio, then you will not see any returns on it. Losses are pretty common in equities as you know.