Zero-Beta Portfolio

Loading the player...

What is a 'Zero-Beta Portfolio'

A zero-beta portfolio is a portfolio constructed to have zero systematic risk or, in other words, a beta of zero. A zero-beta portfolio would have the same expected return as the risk-free rate. Such a portfolio would have zero correlation with market movements, given that its expected return equals the risk-free rate or a relatively low rate of return compared to higher-beta portfolios.

BREAKING DOWN 'Zero-Beta Portfolio'

A zero-beta portfolio is quite unlikely to attract investor interest in bull markets, since such a portfolio has no market exposure and would therefore underperform a diversified market portfolio. It may attract some interest during a bear market, but investors are likely to question whether merely investing in risk-free, short-term treasuries is a better and cheaper alternative to a zero-cost portfolio.

Beta and Formula

Beta measures a stock's (or other security's) sensitivity to a price movement of a specifically referenced market index. This statistic measures if the investment is more or less volatile compared to the market index it is being measured against. A beta of more than one indicates that the investment is more volatile than the market, while a beta less than one indicates the investment is less volatile than the market. Negative betas are possible, and indicate that the investment moves in an opposite direction than the particular market measure.

For example, imagine a large cap stock. It's possible that this stock could have a beta of 0.97 versus the Standard and Poor's (S&P) 500 index (a large cap stock index), while simultaneously having a beta of 0.7 versus the Russell 2000 index (a small cap stock index). At the same time, it could be possible the company would have a negative beta to a very unrelated index, such as an emerging market debt index.

The formula for beta is:

Beta = Covariance of Market Return with Stock Return / Variance of Market Return

A Simple Zero-Beta Example

As a simple example of a zero-beta portfolio, consider the following. A portfolio manager wants to construct a zero-beta portfolio versus the S&P 500 index. The manager has $5 million to invest and is considering the following investment choices:

Stock 1: has a beta of 0.95

Stock 2: has a beta of 0.55

Bond 1: has a beta of 0.2

Bond 2: has a beta of -0.5

Commodity 1: has a beta of -0.8

If the investment manager allocated capital in the following way, he would create a portfolio with a beta of approximately zero:

Stock 1: $700,000 (14% of the portfolio; a weighted-beta of 0.133)

Stock 2: $1,400,000 (28% of the portfolio; a weighted-beta of 0.182)

Bond 1: $400,000 (8% of the portfolio; a weighted-beta of 0.016)

Bond 2: $1million (20% of the portfolio; a weighted-beta of -0.1)

Commodity 1: $1.5 million (20% of the portfolio; a weighted-beta of -0.24)

This portfolio would have a beta of -0.009, which is considered a near-zero beta portfolio.

RELATED TERMS
  1. Beta

    Beta is a measure of the volatility, or systematic risk, of a ...
  2. International Beta

    Better known as "global beta", international beta is a measure ...
  3. High Beta Index

    An index composed of companies with high betas trading on the ...
  4. Unlevered Beta

    A type of metric that compares the risk of an unlevered company ...
  5. Portable Alpha

    A strategy in which portfolio managers separate alpha from beta ...
  6. Smart Beta

    Smart beta defines a set of investment strategies that emphasize ...
Related Articles
  1. Managing Wealth

    Beta: Gauging Price Fluctuations

    Learn how to properly use this measure that can help you meet your criteria for risk.
  2. Markets

    High Beta – Low Beta Stocks Define Volatility Trades

    We compare the Beta values obtained from financial sources. Also, how to compute Beta using Excel.
  3. Managing Wealth

    Beta: Know The Risk

    Beta says something about price risk, but how much does it say about fundamental risk factors? Find out here.
  4. Managing Wealth

    How AQR Places Bets Against Beta

    Learn how the bet against beta strategy is used by a large hedge fund to profit from a pricing anomaly in the stock market caused by high stock prices.
  5. Managing Wealth

    What is a Security Market Line?

    The security market line graphs the systematic risk versus return of the whole market at a certain time, and shows all risky marketable securities.
  6. Markets

    3 Cases When Beta Does Not Measure Volatility of Stocks

    Examine the theoretical and statistical relationship between beta and volatility to identify three factors that limit beta's explanatory value.
  7. Managing Wealth

    Calculating Beta: Portfolio Math For The Average Investor

    Beta is a useful tool for calculating risk, but the formulas provided online aren't specific to you. Learn how to make your own.
  8. Managing Wealth

    How To Calculate Beta Of A Private Company

    We explain two methods for calculating the beta of a private company.
  9. Trading

    Avoid Future Shock By Protecting Your Portfolio With Futures

    Worried about protecting your portfolio of diversified stocks and assets? Using futures with correct strategies can help.
  10. Managing Wealth

    Evaluating Alpha and Beta

    Alpha and beta are risk ratios that investors use to calculate, compare and predict returns.
RELATED FAQS
  1. How does beta measure a stock's market risk?

    Learn how beta is used to measure risk versus the stock market, and understand how it is calculated and used in the capital ... Read Answer >>
  2. How does Beta reflect systematic risk?

    Learn what systematic risk is, what beta is and how it is related to market indexes, and how beta reflects the systematic ... Read Answer >>
  3. What are the differences between delta hedging and beta hedging?

    Learn about hedging strategies, how to delta and beta hedge a security and the difference between delta hedging and beta ... Read Answer >>
  4. What kinds of securities are influenced most by systematic risk?

    Learn what systematic risk is, how investors can measure it with beta and how securities with a beta greater than 1 are most ... Read Answer >>
  5. How does my insurance company determine what premiums I have to pay for coverage?

    Learn about some of the quantitative finance measures that investors without a strong math background can use in analyzing ... Read Answer >>
  6. What's the difference between alpha and beta?

    Learn about alpha and beta, two very important technical risk ratios that investors use to evaluate relative performance, ... Read Answer >>
Hot Definitions
  1. Duration

    A measure of the sensitivity of the price (the value of principal) of a fixed-income investment to a change in interest rates. ...
  2. Dove

    An economic policy advisor who promotes monetary policies that involve the maintenance of low interest rates, believing that ...
  3. Cyclical Stock

    An equity security whose price is affected by ups and downs in the overall economy. Cyclical stocks typically relate to companies ...
  4. Front Running

    The unethical practice of a broker trading an equity based on information from the analyst department before his or her clients ...
  5. After-Hours Trading - AHT

    Trading after regular trading hours on the major exchanges. The increasing popularity of electronic communication networks ...
  6. Omnibus Account

    An account between two futures merchants (brokers). It involves the transaction of individual accounts which are combined ...
Trading Center