Mo 'Beta' Blues: The Risky Strategy of Chasing Risk

A certain frothiness has entered the market. It’s the kind of frothiness you get when fund managers, desperate not to miss the next leg of the rally, start chasing the riskiest stocks for a chance at outperformance. For proof you need look no further than the top 3 performing S&P 500 stocks so far this year.

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In the 41 trading days so far in 2011, three stocks — JDS Uniphase, Micron, and Nvidia — in the S&P have rallied more than 40 percent. All chip names, the catalyst for these outsized returns isn’t clear. None has been the target of a takeout or other M&A activity. JDS Uniphase has been downgraded by three different analysts. Nvidia posted lackluster earnings in mid-February, meeting EPS expectations, and missing revenue estimates.

So what keeps them charging higher? “What’s happening here is that fund managers are chasing performance. In an effort to generate alpha, they’re chasing beta,” said Gary Kaminsky, co-host of the Strategy Session and former money manager at Neuberger Berman. Kaminsky’s point: in an effort to get ahead of a bull market that’s now two years old, money managers are buying up, and bidding up, some of the riskiest stocks around.

Beta measures the added risk (and reward) of owning a particular stock versus the overall market. A beta higher than “1” means that a stock has been historically more volatile than the S&P 500 as a whole. By owning a stock with higher beta, you it means you anticipate outperformance to warrant that added risk. JDSU is currently one of only 40 stocks in the S&P with a beta higher than 2.

“For anyone employing this strategy, I recommend taking a look at a 20 year chart of JDS Uniphase,” said Kaminsky.

“Back in 1999, two-thirds of mutual fund managers were overweight JDSU, a year which saw that stock rally 900%. And then they got burned.” The bursting of the tech bubble murdered high beta names like JDSU: it is still down 97% from it’s ‘99 peak.

Kaminsky highlights another reason not to bet it all on beta: a new study by Interactive Data shows that (contrary to popular opinion) low beta stocks outperform the S&P’s annualized 8.8% return over long time horizons.

"Boring" stocks like McDonalds (beta = 0.63), Colgate Palmolive (beta = 0.60), and Church & Dwight (beta = 0.46) all have annualized returns of more than 13% over the last 20 years.

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