Managing My Portfolio Beta

in volatile markets..

The recent liquidity issues within regional banks, persistent inflation, promises of artificial intelligence and volatile interest rates have made it tough for investors to determine the directional bias of financial markets, let alone valuations. I’ve been playing tactical both increasing and decreasing my exposure to the market. You might ask, increasing and decreasing exposure, “How are you doing that?”.

Well one way is to simply sell your assets and switch to cash if you believe markets are overvalued in a market rally and buy back your assets if you believe markets to be undervalued in market drawdowns. This is just fine but comes with a caveat. One of those caveats is taxes. If you are managing a taxable portfolio, selling any stock or bond with a low-cost basis, will incur a short- or long-term tax on your unrealized profits. For many long-term investors, with sizable unrealized gains, this just isn’t feasible, and the default psychology is to “ride it out”. I completely agree that in the long term a diversified portfolio will be able to ride out the volatility, but I also believe if you have the skill and time, volatility is a perfect time to be tactical.

This brings me to my second option, understanding and managing your beta. For those of you unfamiliar with the term, beta is simply a measure of sensitivity between two underlying’s, in this case your portfolio and the market. If you are familiar with regression, it is the coefficient on the independent variable. For example, we can regress your portfolios returns on the returns of a market portfolio such as the S&P 500. This produces a coefficient. A simple way to think about this is, if your portfolio has a beta of 1.3 and the market moves down by 1% then your portfolio will move down by 1.3%.

Once you have an understanding of your portfolios beta there are a few tools at your disposal. A very simple approach I like to use is to sell futures on a market index that comprises of the assets in my portfolio. In my case I invest in a large portfolio of smaller companies, therefore the Russell 2000 is my universe to hedge. RTY and M2K are futures contracts on the Russell 2000 I trade in times of volatility. If I believe we are coming to a period of lower valuations I sell futures contracts lowering my beta to the overall small cap market, If I believe the markets to be undervalued, I buy back my contracts increasing my beta to the small cap market.

Hope this helps! Happy investing!