Why Higher Returns Doesn't Have to Equal Higher Risk

In his paper titled “Risk Neglect in Equity Markets”, Malcolm Baker of Harvard Business School assembled two portfolios from 1967; one consisted of the 30% of US stocks with the lowest beta; another consisted of the 30% with the highest beta. By the end of the period, $1 in the low-beta portfolio has grown to $190 while the high-beta portfolio grew to just $18.

This is a difference of more than 5% per year.  In addition, the low-beta portfolio was less volatile with a maximum drawdown of 35% compared to the high-beta portfolios maximum drawdown of 75%.

Is the “Low Beta Anomaly” a Farce?

We analyzed the various durations and forms of beta to see if the “Low Beta Anomaly” is all hype:

2-Year Beta

3-Year Beta

4-Year Beta

5-Year Beta

2-Year Up Beta (Beta in Up Markets)

3-Year Up Beta

4-Year Up Beta

5-Year Up Beta

2-Year Down Beta (Beta in Down Markets)

3-Year Down Beta

4-Year Down Beta

5-Year Down Beta

The results were interesting, to say the least…

The following table shows the performance and Sharpe Ratio per quintile of each form of Beta noted above as applied to the S&P 500 Index since 1974:


While stocks with the lowest Beta displayed less risk and higher Sharpe Ratios across the Board, the same cannot necessarily be said for historical returns. The largest difference in returns came from the 5-year Up Market Beta – something that is intuitively hard to understand.  Since 1974, stocks with the lowest 5-year upmarket beta outperformed their high-beta counterparts by 3% per year with a much higher Sharpe Ratio (0.92 versus 0.47).  The largest difference in efficiency (measured by Sharpe Ratio) came from the 5-year total Beta ratio.  Interestingly, stocks with the highest 2-year down market beta outperformed stocks with the lowest 2-year down market beta.

For those planning on utilizing low-beta strategies, pay careful attention to the duration over which the beta is calculated. Try to avoid short-term beta as a buy criteria and focus on long-term beta calculated 5 years or longer.

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