Low Beta Funds

Historically, attractive equity market return is often followed by the uncertainty and turbulence. The current volatility in the equity market (not to be misled by lifetime high of frontline equity indices, which is led by extraordinary performance of few stocks) is followed by the spectacular rise in the stock market during 2017. In the year 2017, the frontline indices generated 28 per cent while the broader index moved even more. Mid-cap and small-cap indices moved up by 48.13 per cent and 59.64 per cent respectively in the same period. The following two years had been painful for the broader indices that witnessed continuous fall for two years (2018 and 2019).



Understanding ‘Beta’

The equity market goes in a cycle and is very hard to predict its exact tenure. Hence, many smart investors try to find the ways in which they can overcome the cyclicality of the market and generate returns better than their benchmarks.



One of them is investing in ‘low beta’ funds or stocks. Among several finance theories proposed by the academia, there are very few which is being adopted by the practitioners and even lesser that is being used as widely as Capital Asset Pricing Model (CAPM). This fundamental theory of finance suggests that return on any investment is directly dependent upon the risk you take, which in this case is represented by ‘beta’. Hence the conventional wisdom will say that higher beta funds should generate better returns in long run. This is because market after all often goes up in the long run and hence, fund with higher beta should generate higher returns. A fund with beta of more than 1 means it is more volatile than its benchmark and moves widely relative to its benchmark in both directions. While beta of less than one means the movement in fund’s net asset value (NAV) will be less than the movement in its benchmark in either direction. Nevertheless, this does not happen in reality. It is actually lower beta fund on an average outperform the high beta fund in the long run.

This can be clearly viewed in performance difference of the funds with beta greater than one and less than one.



To understand if the lower beta actually helps a fund to outperform in longer period, we studied the performance of the equity dedicated funds that have generated best and worst returns in the last 10 years.

Following are the tables that shows the top and bottom performing equity funds in terms of returns in the last 10 years.


Out of the above, we selected four funds to check if there is any truth in the fact that low beta funds prove better long-term bet. The following graph shows the relative performance of the funds since year 2010. You can clearly see how the Invesco multicap fund and Canara Robeco have outperformed the other two funds namely, JM Large cap and Baroda Multi cap.


The above chart has three segments. The top part of the chart shows the cumulative return generated by the funds since April 2010. It shows the movement of every penny that you had invested since the beginning of April 2010.

It means that each rupee invested in Canara Robeco have gradually turned four times its actual worth if compared to the current market price. The second part of the chart shows the daily returns of the funds, which varies from negative 4 per cent to positive 4 per cent. The last part of the chart shows the drawdown (maximum fall from their recent high) of the funds. You can see that funds with better returns have lower drawdown. 

Next we checked the beta of these funds with respect to their benchmarks and found out that the funds that have performed better in the last 10 years to have lower beta. For example, Baroda Multi cap fund had generated annualised return of 7.29 per cent in the last 10 years as compared to Invesco Multi cap fund which has a beta of 0.78 and it gave a return of 16.42 per cent.


Why Low Beta strategy performs

Many of us must be wondering why low beta works, which is actually against the conventional finance wisdom. One of the main reasons why lower beta works is because of simple mathematics. Suppose there are two funds having their average return of 10 per cent in 2 years. One fund that has a higher beta falls by 15 per cent in the first year, then it has to recover 41.2 per cent next year to generate an average return of 10 per cent. However, in case of fund with lower beta falls by 10 per cent in the first year, it needs to rise by less than 35 per cent to generate an average return of 10 per cent in two years. This is the reason why lower beta funds generate better return as they fall less and hence need to rise even lesser to outperform the benchmarks. What also works for the low beta strategy is its relationship with the market cycle. Outperformance of these funds typically come in periods of market fall, while any lag in performance comes when the markets are rising. Nevertheless, a smart fund manager can always shift his assets towards higher beta stocks while market is rising.

The table below shows beta of the funds in rising as well as in falling market. In such cases, the benchmark of the respective fund represents their market. We clearly see that beta of the performing funds are lower in general. Nevertheless, what helps them outperform is lower beta during the falling market. We see beta of the fund changes at different point of time and better performing funds have higher beta during the rising market whereas lower beta during the falling market.


Low beta funds should ideally be generating no alpha, however, in practice it seems that low beta funds are generating higher returns than the high beta funds. This is a market anomaly that has persisted for long and does not seem to go away. Hence, it is likely that low beta funds may keep on generating excess returns.