Question

• Explain the reasons for changes in beta and explain if one should be more concerned with a negative versus positive factor. Be sure to reference volatility.
• Please provide an example of negative Beta.

Answer 1

We have realized that whatever we do, certain risks can’t be eliminated or mitigated. They are systematic or market risks. We now need a measure to quantify or measure this risk separately. This measure is called beta.

The systematic risks of various securities differ due to their relationships with the market. The beta factor describes the movement in a stock's or a portfolio's returns (Rs) in relation to that of the market returns (Rm).

Reasons for changes in beta

• β describes the sensitivity of investment’s return to that of the market. It’s a measure of riskiness or volatility of a stock. It also indicates the returns an investor should expect for every 1% change in the market. Since market conditions change, returns of the stock change. The changes lead to volatility which leads to change in beta.
• Stocks with a β >1 are highly sensitive to market movements, hence market movements create magnified impact on them

• Stocks with a β <1 are less sensitive to market movements
• Stocks with negative β will have counter impact of market movements
• β of a portfolio will be market value weighted average of the β of the individual securities in the portfolio
• Since β is a measure of risk, it will directly impact the expected return on a security because we have learnt earlier that risk and return go hand in hand and can’t be seen in isolation

We have seen earlier that return is measured by the price of a security at the time of investment and at the end of horizon period, so any changes in β will impact the security’s price. Higher the β, higher is the perceived risk, lesser should be the price of the security and higher should be the expected return on it.

One should be more concerned with a negative versus positive factor. This is because we are concerned not only with the quantum of the impact of market fluctuations but also the direction of market fluctuations on the stock returns. A negative beta tells us that stock moves in direction opposite to market. In that case the stock and the market are negatively correlated and hence impact of diversification can be better.

Examples of negative beta:

Stocks in pharmaceutical sectors such as Pfizer, Dr. Reddy's Laboratories, Cipla etc demonstrate negative betas. They move against the market. When market rises, their stock prices usually fall and vice versa. Hence, they serve good example of negative betas.