Investing in Stocks: Understanding Negative Beta
Investing in stocks means understanding a multitude of financial metrics and terms, and beta is one of them. If you’re someone who pays a lot of attention to stocks, you might be familiar with the concept of beta, which is a way to measure a stock’s volatility compared with the broader market. But let’s say you have a down beta? Does this bode ill for the stock? Or a below-the-radar opportunity for canny investors?
In this article, we will explore:
- What a negative beta means
- How does it affect your investment decisions
- Why do some stocks have this seemingly counterintuitive number
By the time you’re finished here, you should understand exactly what negative beta stocks are and how they could fit into an investment strategy.
What Is Beta in the Stock Market?
In order to understand a negative beta, you first need to know what beta is. Beta is a measure of how volatile a stock is compared with the overall market. Beta is typically 1 for the overall market.
Here’s how beta works:
- Beta = 1: The stock changes price at the same rate as the rest of the market. If the market is up 5%, the company’s stock should also be up 5%.
- Beta > 1: Stock is more volatile than the market. If a stock has a beta of 1.5, for example, it will rise 7.5% when the market goes up by 5%.
- Beta < 1: The stock is low volatile compared to the market. A beta of 0.5 implies that the stock will rise or fall at half the pace of the market.
- Beta = 0: The stock does not have any relationship with the market.
- Beta < 0 (Negative Beta): Stock moves in the opposite direction of the market.
A beta negative is hardly ever found, but when it is available, it is of interest to investors.
What Does a Negative Beta Mean for a Company?
When a stock has a negative beta, that means the price tends to move in the opposite direction of the overall market. The stock may fall in value if the market goes up 5%. Conversely, when the market sinks, the stock may climb.
Why Does This Happen?
The negative beta is often characteristic of the business. Those types of stocks are typically tethered to industries or assets that tend to do well during financial stress or economic downturns.
A few common examples of negative beta are:
1. Gold And Precious Metals Stocks
Investors treat gold as a “safe haven” store of value. Gold historically goes up in market sell-offs as investors seek its perceived safety. This relationship leads to a negative beta for gold mining companies.
2. Inverse ETFs
Some funds, such as inverse ETFs, are designed to move contrary to the market. They’re specialized investments and not customary stocks, however, their beta chart patterns out as if they WERE a negative beta stock.
3. Exotic or Unusual Assets
Some companies, like some utility or insurance stocks, may have a negative beta in a particular sort of market.
If you find a stock with a negative beta, you need to investigate why the security is negatively correlated. This will inform where to invest.
Negative Beta Stock Example
Barrick Gold Corporation
This mining behemoth frequently displays a near-zero or even negative beta, thanks to its tight relation with the prices of gold, which generally increase as the stock market goes down.
SPDR Gold Shares (GLD)
GLD is not a stock, but rather an exchange-traded fund (ETF) that closely mirrors the price of gold. That it has a negative beta is one reason why investors reach for it in volatile markets.
If you understand these examples, you can utilize similar strategies in the marketplace.
What Does Negative Beta Mean for Your Portfolio?
-54 Negative beta stocks can serve as important tools for portfolio diversification and risk reduction.
1. Hedge in the Face of Market Volatility
As a result of the propensity of negative beta stocks to outperform in market downturns, they are used as a hedge to counter broader market declines. Investors tend to use these stocks to recover or balance their losses in regular equities that occur in bear markets.
2. Lower Portfolio Risk
Adding negative beta securities can actually reduce the overall risk in your portfolio. Because offsetting movements of other investments cancel and make returns on negative beta stocks.
3. Steady Consistency Across Economic Regimes
If a recession does happen, negative beta stocks would give you some returns. If the balance of the portfolio is losing ground in a bear market, your negative beta stocks should go a long way in easing the pain.
That said, you don’t want to load up your portfolio with plenty of negative beta stocks. They serve to balance rather than dominate a portfolio.
Pro Tip: A smartly diversified portfolio would house a mix of assets with different beta levels to effectively balance risk and reward.
Risks of Negative Beta Stocks
Negative beta stocks have certain advantages, but they are not without a downside. They do, however, come with some risk — here are some to keep in mind if you are considering adding them to your portfolio:
1. Limited Growth Potential
Many negative beta stocks are in industries that don’t enjoy high growth rates on a consistent basis. For example, gold stocks rely on commodity prices, which can become stagnant in bull markets.
2. Market Misinterpretation
There are occasionally extenuating factors, like short-term market pressures, that cause a stock’s beta to fluctuate. Beta over time is hugely important to watch for accuracy.
3. Poor Returns in a Bull Market
If the market in general does well, negative beta stocks won’t do as well. When the market is going up, as it has for more than a decade, money pours into risky growth stocks, leaving less appealing, so-called negative beta assets in the dust.
And to take into account the phenomena like these that we have outlined in this post in your own investment strategy.
Negative Beta Stocks – Is it Worth It?
Your answer will vary based on your own investment objectives and risk tolerance. Generally speaking:
- If you are looking to reduce risk, negative beta stocks may be a good investment.
- But if you’re going for aggressive growth, the paltry returns of negative beta stocks in raging bull markets may not fit your style.
Who Is a Negative Beta Stock Suitable For?
- Conservative investors at risk with a choppy market
- Active Fund Traders Paired with Investors who Dabble a Bit
- Experienced dual filers
- Short-term investors looking to hedge against anticipated economic activity
If you’re not certain that a negative beta stock makes sense for your investment plan, consider speaking with a financial advisor or talking to an expert about your strategy.
Final Take on Negative Beta Shares
A stock with a negative beta is more than just a quirky fluke of the financial world. It is an alternative approach to understanding risk, return, and portfolio construction. Knowing what a negative beta means for a stock can lead to new diversification possibilities and potentially less volatility for your investments.
Don’t forget. Investing is just as much about understanding the risk, or lack of risk, you are taking as it is about getting a return. Negative beta stocks allow you to do this. While it’s probably not realistic or feasible to own only negative beta stocks, they can help you build a portfolio that is practically immune to bad markets.
