Friday Podcast 21st September 2012- What is beta and how to look at it

20 Sep 2012

Transcript of the Podcast

Hi This is your editor Arjun Parthasarathy speaking. The Friday podcast is a new feature for the followers of Investors are Idiots.com. The brief podcast will select one topic for analysis and will be released every Friday.

This week’s topic is on “ What is beta and how to look at it”

The sudden euphoria in equities is now throwing up talk of Sensex and Nifty at 20,000 and 6000 levels respectively by the end of fiscal 2013, an 8.5% plus gain from current levels. The so called experts are now asking you to take on high beta stocks as risk on trade increases in the market. However beta is a greatly misunderstood indicator and one has to be careful on how to use beta. Let me explain further.

Beta is the movement in a particular stock with respect to its index. The index beta is always one. A high beta stock is a stock that has a beta higher than 1 while a low beta stock has a beta less than 1. For example if Reliance beta is 1.2, for every rise or fall of 10% in the Nifty index, Reliance stock price will rise or fall by 12%. Similarly low beta stocks like Asian Paints that has a beta of 0.35, will rise or fall much less than the Nifty rise or fall. If Nifty rises by 100%, Asian Paints is expected to rise by only 35% while if Nifty falls by 50%, Asian Paints will fall by 17.5%.

In rising markets experts tell you to buy high beta stocks to outperform the index while in falling markets experts tell you to buy low beta stocks. The main issue here in using beta to outperform markets is that a fundamental expected move in an index is being clubbed with a technical indicator that is beta.

Beta values are derived from past movement in markets and stock prices. As you must have by now realized, past movements are the worst indicator of future movements. A trader following only technical analysis blindly can use beta for the extreme short term (say a hour or a day) beta may live up to its values. But in the long term, beta is not an indicator for investors to follow.

The example of Asian Paints says it all. Asian Paints has returned over 280% over the last five years and the Nifty has just returned around 12%. The beta of Asian Paints at 0.35 is completely misleading looking at the last five years performance. There were many fundamental factors going positive for Asian Paints, making it a huge outperformer over the Nifty and those fundamentals are not captured in beta.

The bottom line on beta is leave it to the experts and you follow the fundamentals that you understand while investing.

Thank you for listening in. Have a good weekend.

About the Author

Arjun Parthasarathy has over 25 years experience in financial markets. He has worked across platforms of fund management, proprietary trading and research and across segments of equities and fixed income. Arjun has worked with reputed institutions including Citigroup, IDFC Mutual Fund, Sundaram Mutual Fund and IDBI Bank. He has done his MBA from University of Hull UK and MA in Economics from the University of Poona. Arjun has authored the book, The Rich Investor, published in 2012.

5 Comments

Rahul chindaliya September 21, 2012 at 4:17 am Log in to Reply

"The bottom line on beta is leave it to the experts and you follow the fundamentals that you understand while investing." Once again a very enchanting topic by arjun Sir, Moreover, the last line says it all- "leave it to the experts". Tracking beta isn't that easy for individual investors. In my opinion, a better option here would be to go through the Mutual Fund route. One would hardly find a top performing fund with relatively higher beta than its benchmark. Fund manager's tweak their portfolio to retain beta value at lower then their respective benchmarks. This limits the overall downside risk.
- admin September 21, 2012 at 4:32 am Log in to Reply
  
  Hi Your observation is true. However fund managers who pick stocks on fundamentals and not on technicals should not be following beta. Beta is more for traders, hedge funds that use computer models for outperformance etc. It is a short term technical measure and not a long term fundamental measure.
Rahul chindaliya September 24, 2012 at 5:00 am Log in to Reply

Your opinion is absolutely correct- beta is for technical short term analysts- not fundamentals. What i've observed is that all through the past year, the best of mutual funds, have their portfolio beta at >1 vis-a-vis their benchmarks. Scheme Name Benchmark Index R Squared Beta R Squared Beta Reliance Equity Opportunities BSE 100 0.85 1.16 0.79 1.15 UTI Master Value BSE 200 0.81 1.15 0.72 1.17 Quantum Long-Term Equity BSE Sensex 0.92 1.14 0.93 1.11 Principal Dividend Yield CNX 500 0.93 1.10 0.85 1.13 ICICI Prudential FMCG CNX FMCG 0.77 1.08 0.25 0.51 Franklin India Prima CNX 500 0.88 1.07 0.78 1.08 HDFC Growth BSE Sensex 0.92 1.06 0.93 1.03 Birla Sun Life Dividend Yield Plus CNX 500 0.86 1.05 0.79 1.08 HDFC Top 200 BSE 200 0.98 1.04 0.96 1.10 Canara Robeco FORCE - Ret S&P Nifty 0.82 1.04 0.82 1.04 Reliance Banking CNX Bank Nifty 0.96 1.02 0.87 1.60 UTI Banking Sector CNX Bank Nifty 0.99 1.01 0.90 1.58 Sundaram Financial Services Opp - Ret CNX Bank Nifty 0.97 1.01 0.89 1.58 Birla Sun Life MNC CNX MNC 0.76 1.00 0.61 0.89 IDFC Premier Equity - Plan B BSE 500 0.81 0.99 0.69 1.00 IDFC India GDP Growth BSE 500 0.91 0.99 0.89 1.07 UTI Equity BSE 100 0.93 0.98 0.91 0.99 Tata Pure Equity BSE Sensex 0.87 0.97 0.87 0.94 UTI Dividend Yield BSE 100 0.92 0.97 0.89 0.98 DSP BlackRock Equity - IP CNX 500 0.94 0.96 0.87 0.99 ICICI Pru Banking and Financial Svs - R BSE Bankex 0.98 0.95 0.91 1.47 Religare Banking - Reg CNX Bank Nifty 0.98 0.94 0.90 1.48 Birla Sun Life Frontline Equity - Plan A BSE 200 0.98 0.94 0.96 0.99 DSP BlackRock Small and Midcap CNX Midcap 0.93 0.93 0.71 1.20 ICICI Pru Focused Bluechip Equity - IP I S&P Nifty 0.97 0.93 0.97 0.93 Tata Dividend Yield CNX 500 0.90 0.93 0.81 0.95 DSP BlackRock Top 100 Equity BSE 100 0.97 0.93 0.95 0.94 ICICI Pru Focused Bluechip Equity - Ret S&P Nifty 0.97 0.93 0.97 0.93 SBI Magnum Bluechip BSE 100 0.95 0.92 0.94 0.94 Franklin Build India CNX 500 0.93 0.91 0.83 0.92 Axis Equity S&P Nifty 0.93 0.89 0.93 0.89 Kotak Select Focus S&P Nifty 0.90 0.89 0.90 0.89 Birla Sun Life Mid Cap - Plan A CNX Midcap 0.92 0.88 0.76 1.18 ICICI Prudential Dynamic Plan S&P Nifty 0.87 0.88 0.87 0.88 Franklin India Bluechip BSE Sensex 0.94 0.88 0.95 0.86 UTI Mid Cap CNX Midcap 0.89 0.88 0.66 1.11 UTI Mastershare BSE 100 0.97 0.87 0.95 0.89 UTI MNC CNX MNC 0.76 0.86 0.59 0.75 HDFC Mid-Cap Opportunities CNX Midcap 0.95 0.84 0.73 1.09 Franklin India Prima Plus CNX 500 0.94 0.84 0.90 0.89 ICICI Prudential Discovery CNX Midcap 0.88 0.84 0.75 1.15 Sundaram SMILE - IP CNX Midcap 0.89 0.83 0.78 1.14 SBI Magnum Umbrella - Emerg Buss BSE 500 0.69 0.83 0.57 0.82 Sundaram Select Midcap - IP BSE MID CAP 0.89 0.81 0.72 1.05 Canara Robeco Equity Diversified BSE 200 0.92 0.81 0.86 0.84 IDFC Sterling Equity CNX Midcap 0.89 0.78 0.67 0.99 DSP BlackRock Micro Cap - Reg BSE SMALL CAP 0.84 0.75 0.58 1.06 Canara Robeco Large Cap+ BSE 100 0.98 0.73 0.96 0.74 Axis Midcap BSE MID CAP 0.90 0.73 0.73 0.95 UTI Wealth Builder - Series II BSE 100 0.81 0.66 0.79 0.67 Reliance Small Cap BSE SMALL CAP 0.93 0.63 0.80 0.98
Rahul chindaliya September 24, 2012 at 5:03 am Log in to Reply

Oops ! trying to put a table but look what happened- Sorry.If you can please put up this table, we'll be able to correlate that the top performing Equity funds has kept their portfolio beta ~1 vis-a-vis their respective benchmarks.
- admin September 24, 2012 at 6:29 am Log in to Reply
  
  Good observation. The issue here is when markets are negative, there is a clamor by distributors to keep beta below 1 and if five funds do so then everyone else follows. Many times this herd positioning is not driven by a fund managers conviction but more by marketing compulsion. Rating funds whose investment objectives are based on fundamentals and not technicals, using beta is not ideal.