Beta Breakup
Investors have often viewed beta as a reliable compass for understanding market movements. Like most statistics in financial markets, that statement is only mostly true. You can usually count on beta. Historically, market beta (the degree to which stocks move in relation to the broader market) has been the primary driver of portfolio returns on a day-to-day and month-to-month basis. Calculate the beta of a stock’s portfolio, multiply that by the market return, and that gives you a prediction of where the portfolio’s return will be over the corresponding period.
Recently, however, that relationship appears to have broken down.
For example, low beta names within low volatility ETFs have underperformed the market by approximately 40% since 2019, even though their beta would have implied only about 17% of underperformance.[1] Similarly, software and services have sharply underperformed the S&P 500 Index, diverging meaningfully from what their group beta would predict relative to the broader market. In this post, I explore both examples in more detail.
Since the second quarter of 2025, cross-sectional moves in the market have been unusually large by historical standards; in other words, beta effects have been muted relative to idiosyncratic effects. These large idiosyncratic moves suggest that a subset of stocks have broken away from the pack. Normal correlation patterns have broken down, leading investors to ask: What is different this time, and will it persist? Are these moves driven by short-term sentiment or is there something like artificial intelligence (AI) that has fundamentally shifted how companies and markets behave?
For the first example, note the performance of MSCI’s low volatility strategy vs. the cap-weighted MSCI USA Index (see Figure 1). Low volatility strategies tend to underperform cap-weight indices in extreme rising markets but over time, particularly over full market cycles, low volatility indices have in some periods kept pace with cap weighted indices across a range of geographies and market capitalizations (although results vary across time periods). There have been times in the past, like 1999 or 2006, where low volatility strategies have fallen far enough behind to be nearly written off, only for them to storm back once exuberant markets sober up.
Figure 1 plots the summed returns of the MSCI USA Cap-Weighted Index as well as the MSCI USA Low Volatility Index. Along the right axis, the aggregated active returns of the low vol vs the cap-weighted index are plotted. What is eye catching is the incredible run that the cap-weighted index has been on. Since before COVID-19, the cap-weighted index (green line) has outperformed this portfolio of low-risk stocks (blue line).
Figure 1:
MSCI USA cap-weighted index vs. MSCI USA low volatility index RETURNS
January 1, 1999 – January 31, 2026
Source: MSCI. Returns shown represent total returns in USD unless otherwise noted. Indexes are unmanaged and not available for direct investment
In a roaring market, this is not unusual. In fact, we normally observe that during market downturns the low volatility index gains its ground back. What is perhaps most interesting here is the tail end of the graph – in particular, the period since April 2025.
A closer look shows that the normal dependable correlation between the two strategies has broken down. Since April, the slope of the cap-weighted line is steeper than that of the low volatility index, and there was a slight downturn that was observed in the cap-weighted index that did not occur in the low volatility index. Whatever is driving the cap-weighted index does not appear to affect low volatility stocks in the same way; this is distinct from what we’ve seen in the past.
This leads me to a related graph: the performance of software and services over the past year. As with most sectors and industries, the dominant factor in explaining day-to-day performance is beta. Market level fluctuations are the dominant risk factor. Much as the low volatility index appears dislocated from the cap-weighted index since April 2025, we see that software and services seem to have dislocated from the broader index.
Figure 2 plots the returns of the S&P 500 Index (green line) and the State Street Software and Services ETF (XSW-US) over the trailing year. The S&P 500 Index has delivered relatively steady performance, but software and services (blue line) have declined sharply. On a beta-adjusted basis, the underperformance of the subindustry has been especially pronounced.
Figure 2:
S&P 500 Index vs. State Street Software and Services ETF (XSW-US) Returns
March 1, 2025 – February 28, 2026
Source: FactSet. The ETF is referenced for illustrative purposes only and should not be considered an investment recommendation.
In the decades-long competition of software vs. hardware (and now software vs. AI), the market has increasingly discounted the software segment, implying structurally weaker growth and profitability expectations relative to hardware and AI-exposed firms. Market pricing suggests there is a fundamental shift in how companies co-move with the market.
How firms correlate with the market (or beta) is typically driven by line of business. For example, utilities tend to outperform luxury goods companies when markets fall since demand for something like electricity is likely to hold up better in bad times than demand for luxury goods. A change in correlations suggests that the forces driving the market have not only shifted stock returns, but also altered which sectors are positioned to outperform in risk-off versus risk-on environments.
The current indication is that many companies, including software and services, could lag broader markets as markets elevate. That would be a distinct change from the past where, over time (despite gyrations and fluctuations), stocks as a whole through beta have mostly moved together in the short term.
Will this be the new normal? Potentially. A more likely explanation is that investors have short-term memories, and we haven’t had a significant recession since COVID-19 in 2020. The COVID-19 recession was highly idiosyncratic: higher-beta technology firms such as Zoom and Google outperformed even as the broader economy contracted.
This may have given investors the wrong idea. In a more traditional downturn, absent a structural shift toward remote work and digital substitution, market leadership may look materially different. Today’s high-flying, richly-valued firms may not retain leadership if speculative growth narratives are challenged during a cyclical slowdown.
In sum, I’ve sought to highlight two instances where diversified portfolios of stocks have performed outside of their normal expectation as markets rise and fall. If the low volatility strategy discussed here represents the defensive anchor of equity beta, and software represents the high-duration growth anchor, then simultaneous distortions in both could suggest not only a sector rotation but a potential regime shift in how equity risk is priced. However, markets may not be pricing a new economic structure. They may be pricing the last recession.
About Intech
Intech is a global quantitative asset manager that applies advanced mathematics and systematic portfolio rebalancing to harness a reliable source of excess returns and a key to risk control – stock price volatility. Intech applies its investment approach across five investment platforms which differ by risk-return objective: relative or absolute. Intech also integrates fundamental-based information to identify stocks with favorable underlying characteristics, complementing its volatility-based models that target stocks with attractive trading profit potential due to their volatility characteristics. These strategies only differ by the client’s desired benchmark and risk budget and include enhanced equity, active equity, defensive equity, extension equity, and absolute return investment solutions within the U.S., global, and non-U.S. regions.
