This blog is the second of a two-part series examining the anomalous dislocation of equity betas we observed in the drawdown during March 2020. Part 1 looks at the sharp decline in the stock beta correlations and Part 2 examines the narrowing of the overall beta spread.
The unraveling of beta persistency in March is surprising, but it is only part of the story. An important ramification is a concurrent change in the distribution of betas across the equity market.
The significant number of low-beta stocks that underwent a dramatic increase in their betas is a prime example of this shift in distribution. Far fewer stocks at the end of March appeared defensive as measured by this attribute. Stocks that may previously have provided some downside protection were, in some cases, falling even more sharply than the market. And perversely, some were outperforming the market in bear market rallies!
To see the shift in beta distribution more clearly, we compare the distribution of betas for the Russell 1000 Index on February 29, 2020, to that on March 31, 2020 (Figure 1). The two bars on the left and right show the overall change in distribution, with the number of stocks with a beta of less than 0.50 falling from 93 to only 23 over this month.
Furthermore, you can see exactly what happened to those 93 previously low-beta stocks in the pie-chart. Eighty-five percent of them actually left the category, with only 14 of the original 93 remaining. What is more, the beta for 18 of them actually increased above 1.0 in the space of a month!
A related observation to the sharp drop in the number of low-beta stocks is the decrease in the spread of stock betas available to investors during March 2020. Figure 2 plots the month-to-month change in the 90th (high) and 10th (low) percentiles of stock betas in the Russell 1000 Index. From this view, you can clearly see that the range of beta tightened sharply during March, largely because of the dramatic rise in betas for traditionally low-beta stocks.
The absolute difference between the highest and lowest beta stocks was only 0.69 at the end of March, which is close to the all-time low of 0.64 and well below the long-term average of 1.13. What’s more, the 10th percentile stock beta was a lofty 0.73, equal to the highest it has ever been. In short, equity investors found very few avenues for downside protection during this recent market collapse.
Size Mattered for Low-Beta Stocks
While low-beta stocks suffered a sudden, substantial sell-off at the end of the first quarter of 2020, the bottom quintile of beta did, in aggregate, outperform the broad index during the quarter. However, even a cursory analysis reveals that this outperformance was not broad-based, but concentrated in larger-cap stocks.
To see this, we divide the bottom beta quintile of the Russell 1000 Index into five sub-quintiles based on market cap (of about 40 stocks each), and compare the performance for Q1 2020 of each of these sub-quintiles. Figure 3 shows that the lowest three market-cap sub-quintiles actually underperformed the index. Further research is needed to determine whether this level of domination of size over beta has any historical precedent.
Implications for Portfolios
What does this mean for your portfolio? Investors and consultants will no doubt look closely at how their portfolios responded in this unique environment. This can indeed offer some insights into the benefits of diversification at the overall portfolio level. However, we caution against drawing any firm conclusions based on a short-term anomalous period. We expect markets to normalize.
If you’d like to gain fuller insight into the unusual shift in equity betas last month and the implications for your portfolio, we invite you to download our paper, “March Mayhem: Was Your Portfolio Betrayed by Beta?”
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