Bank On High Beta Stocks For Faster Recovery

Bank On High Beta Stocks For Faster Recovery

The markets are up by more than 25 per cent from the lows posted in March 2020. This movement has indeed come as a surprise to market participants not just for the fact that the markets have bounced back but for the speed of recovery. However, in such a situation, investors lose focus and ignore the basics of how the markets function. As Geyatee Deshpande explains, it is the high beta stocks that have the capacity to recover faster

There is an old saying: “Higher the risk, higher should be the expected returns in the equity markets.” This quote can be interpreted in several different ways by different investors. But on a more practical level, what happens is that the minimum returns go to passive investors who have safety on their agenda and would not like to be the cheerleaders of market volatility and variability. Maximum returns are realised by those who observe the market moods closely and are alert while exercising their intelligence and investing skills.

One may thus notice that mere high risk-taking activity does not guarantee maximum returns contrary to the simplistic view of greater the risk, greater are the returns, as followed by several novice investors. The returns will be maximised if the game of portfolio management is understood holistically and enough skill is possessed by the investor to manage the portfolio in such a way that returns are optimised. 

Understanding the role that the ‘beta’ of a stock plays in managing a portfolio is crucial for investors to stay in the game longer and harvest profits. In fact, managing the beta of the portfolio skilfully is crucial to ultimate success in the markets. 

Importance of Beta

Simply put, beta tells us the risk level of the stock. In other words, it is the measurement of investment security’s volatility in returns relative to the entire market. Stocks with higher beta values are supposed to reflect higher variability in returns and hence considered more risky. For example, if Indusind Bank reflects a beta of 1.71 and Axis Bank reflects a beta of 1.48 while Cadila Healthcare reflects a beta of 0.5, the indication is that the returns of Indusind Bank and Axis Bank will be highly volatile. Hence, these high beta stocks should be considered risky by investors. On the other hand, Cadila Healthcare can be considered less volatile and hence less risky. 

The other way to interpret beta values is that Indusind Bank can be expected to inch up by 17 per cent in case the Sensex goes up by 10 per cent while Axis Bank with a beta value of 1.48 implies that the stock can be expected to move up by 14.8 per cent when the Sensex inches up by 10 per cent. Cadila Healthcare with beta value of 0.5 suggests that the stock may gain a mere 5 per cent in case the Sensex goes up by 10 per cent. Similarly, high beta stocks can be expected to fall sharper when the Sensex corrects and low beta stocks can be expected to fall by a lesser percentage as compared to the key benchmark index.

Beta values are relatively easy to decipher and hence are popular amongst market participants. The trick to beating the markets using beta values is to know when to include high beta stocks and when to increase the weightage of low beta value stocks in a portfolio. Sound portfolio management practice suggests including high beta stocks when the markets are in a bullish mode and including low beta stocks in the portfolio when the markets are in a bearish mode. Of course the quality parameters for both high beta and low beta stocks are not to be compromised.

Market Watch

If we look at the market performance, we find that Nifty Bank has slipped down by nearly 30 per cent in the past three months while Nifty is down by 18 per cent in a similar period. Banks and financial stocks usually are high beta stocks. Nifty Mid-Cap index, which includes high beta stocks, is down by 25 per cent while Nifty Pharmaceutical index, which includes relatively low beta stocks, is up by 13 per cent in the past three months. The only other NSE index that has delivered positive returns in a similar period is NSE Quality 30 index, which is up by 6.30 per cent.

It includes only those top 30 stocks that satisfy quality parameters based on revenues, profitability and margins. Taking into account the market corrections of 2008 and 2014, we find that high beta stocks have shown a tendency to recover faster (post marker correction) than the low beta stocks. As far as the recent vertical fall in the market goes, we find that on an average the high beta small-caps have recovered by 47 per cent since the markets bottomed out in March while the low beta stocks have recovered to the tune of 28 per cent on an average.

Portfolio Beta
​It is the measure of the systemic risk of all securities in a portfolio, i.e. the risk that cannot be diversified. It is the equal weighted average of the beta coefficient of all securities in the portfolio. A beta of 1.05 relative to the S&P 500 implies that if the sensex excess return increases by 10 per cent, the portfolio is expected to increase by 10.5 per cent.

Conclusion

When it comes to investing in stocks, the most secure way to beat the markets is to consistently invest in quality stocks in a diversified manner. This is a proven and safe strategic portfolio management decision that you can make. Further, beating the markets is also about several intermittent tactical portfolio decisions that can amplify portfolio returns. Banking on high beta stocks while the market is in a recovery mode or in risk-on mode is one such tactical strategy that can help generate alpha as is the case of betting on low beta stocks from defensive sectors when the market outlook is uncertain or is in a risk-off mode.

A common mistake that an investor makes is betting on select sectoral stocks for all seasons, i.e. betting on the same stocks in both the risk-on as well as the risk-off mode. In fact, the churning of a portfolio is quite the norm when the markets are volatile and in a correction mode. Portfolio churning is a must and so is sectoral rotation. While stirring a portfolio, investors must carefully consider the beta values of stocks before adding them to the portfolio. Amongst several other parameters it is important to assess how the overall portfolio beta is impacted by adding a high beta or low beta stock. 

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