Recently we provided a post with a lesson about ABCs of portfolio exposure (see How Exposed Are You? A Brief Lesson In Exposure!).
In this post, we are going to take exposure to a whole new level. This week we will explain Beta Exposure.
Yes, that is right! Beta exposure.
I am sure you may have heard a smart sounding portfolio manager talk about his beta exposure on CNBC and wondered what the heck he was talking about? Well now you too can amaze your friends families and sound smarter than anyone should be by using this term too!
So let's start with the basics. What is Beta?
According to www.investopedia.com, beta is "a measure of volatility, or systematic risk, of a security of portfolio in comparison to the market as a whole." In English, it is how much a security moves in relation to its benchmark.
As an example, an ETF like the iShares Dow Jones Select Dividend Index (NYSEARCA:DVY) has a beta of .70 as compared to its benchmark, the S&P 500. This means when the S&P 500 moves up 1%, it is likely DVY has only moved up .70%. If the S&P 500 likewise falls 1%, it is probable that DVY will only fall .70%. So it is less volatile than the underlying index and has a lower beta.
Here is another example, the Materials Select Sector SPDR (NYSEARCA:XLB) has a beta of 1.2 as compared to its benchmark, the S&P 500. This means when the S&P 500 moves up 1%, it is likely XLB has moved up 1.2%. If the S&P 500 likewise falls 1%, it is probable that XLB will more than 1.2%. So it is more volatile than the underlying index and has a higher beta.
So what does this have to do with portfolio exposure?
Easy! Smart managers also look at their overall portfolio on a beta basis. In English this means they determine the weighted average beta for all their holdings relative to each holdings percentage of the total portfolio. The total of these betas is the portfolio beta.
When managers feel markets may turn choppy or decline, they attempt to reduce the beta of their holdings by selling high beta positions and buying lower beta positions. When managers feel markets want to head up, they tend to increase the beta of their holdings by purchasing higher beta positions.
In layman's terms, it is a way of keeping the same number of positions but either supercharging the ability of those positions to outperform or, in the case of lowered beta, reducing portfolio risk while still keeping the present exposure.
So just recently you heard me say that our equal weighted portfolio was now 50% exposed to the market (75% net long and 25% net short). I also told you that same exposure was just .06 on a beta basis.
So if the beta for the S&P 500 is 1.0? Am I leaning towards more aggressive beta exposure or less beta exposure?
If you said, less aggressive beta exposure, give yourself a pat on the back.