Why is collecting beta a good thing?

"But, as a trader, I love the idea of having a market neutral book that *collects beta in a smart risk-adjusted way.*

Can someone translate this to English please.

Thanks.

85% of active managers fail to produce alpha consistently in large cap stocks. IDK what asset class he/she is specifically referencing, but capturing ‘beta’ is the cheapest way to produce long term full market cycle returns. There are thousands of factors out there that correlate with stock returns, only few are actually statistically significant. Here, beta just means market exposure which also means passive management which is cheaper than active and won’t produce excess returns. So, since research suggest for certain asset classes active stock picking is a stupid idea, so you might as well just follow an index. I’m guessing that’s why they say it’s a good idea. But, you’ve given us literally no context so I could have argued anything else too.

Here is a section of the article:

" Diversifying with over 15 uncorrelated return streams and balancing out your return per unit of risk, through sizing and leverage (ie, leveraging bonds to equal equity on a return per risk unit basis), can get you to a balanced global or market-neutral position.

_ This is where your risk is balanced out and you’re effectively clipping beta coupons from global markets and various asset classes. _

An important note I should make is that to build this market-neutral book you really have to understand cross-asset correlation.

Different asset classes will perform well in some stages and less well in others [growth and inflation]. But, as a global macro trader, I love the idea of having a market neutral book that collects beta in a smart risk-adjusted way."

Questions:

  1. When he refers to clipping beta coupons, is he referring to buying bonds with options to achieve the same return as equities or borrowing money and purchasing bonds?

  2. For example, if equities go up 5%, bonds go down 5% and he collects or is “clipping coupons” but isn’t the coupon payment baked in the 5% - essentially no added benefit?

  3. Lastly, “having a market neutral book” to me sounds like he is not making money -so why is adding beta (smart risk) good if he is neutral?

Thanks!

I’m pretty sure that what he means is selectively adding market sensitivity (beta) when the market is doing well and removing it when the market is doing poorly.

When he uses the word “coupon”, he doesn’t mean a coupon payment on a bond. He means it metaphorically, like taking advantage of coupons in the newspaper for the local supermarket.

The “coupon” in this example would be “Equities, 3 for $4 with coupon”; equities are on sale (i.e., are going to go up 5%), so you buy those, but bonds aren’t on sale so you don’t buy those.

Market neutral simply means that beta = 0; you still get alpha (i.e., returns that have zero correlation with market returns), which you hope is positive. If you think that the market will do well, then you add beta exposure while maintaining your alpha, so you get positive returns that have nonzero correlation with market returns as well as positive returns that have zero correlation with market returns.

You’re welcome.

By the way, all of those words probably amount to a bunch of hooey: he’s trying to predict (and time) the market, and that has not worked particularly well historically.

Will Rogers said much the same thing as this guy, but far more elegantly: “Don’t gamble; take all your savings and buy some good stock and hold it till it goes up, then sell it. If it don’t go up, don’t buy it.

Word!! :+1:

Many thanks for your explanation, S2000magician.

My pleasure.

Beta literally has a formula. On a high level it is about the change in the investment relative to the stock market. So his quote is essentially saying that his base goal is to have a beta of 0, or market neutrality and add beta when the juice is worth the squeeze. This is essentially adding beta only when it produces alpha, or risk adjusted returns. Imo it’s mostly bs because though some investments do have beta that is generally higher or lower than others, it is not always consistent. Lastly alpha is usually measured after the fact.

That’s better.

I’m pretty sure that that’s completely wrong.

You want to add beta when beta × (change in market return) is positive. It has nothing to do with alpha.

His words not mine. Anyways you don’t know the level of return similar to the level of risk.

i feel like even a lot of passive managers don’t know what they are doing and fail to replicate indexes.