How the COVID Beta Shift Impacted Venn’s Low Risk Factor

Market movements during the coronavirus pandemic have shifted the risk characteristics of many stocks. Industry commentators ¹ and news outlets have posted about this shift. For example, a Wall Street Journal (WSJ) article published in late July reported that sectors once viewed as higher risk, such as Technology and Health Care, have behaved like “safety plays” during the pandemic, while defensive stocks, such as Utilities and Real Estate, have declined notably. In an exhibit titled “Shifting Risk”, the article shows how betas ², a measure of how risky a stock is relative to the broader equity market, have shifted during the pandemic among sectors. 

Betas have decreased for the Technology, Health Care, and Pharmaceutical sectors. While certain technology stocks, especially those like Zoom in the “work-from-home” category, might have been viewed as speculative growth stocks before the pandemic, they are now behaving more like recessionary plays. To highlight an extreme case, Zoom’s stock went from a pre-pandemic beta greater than 1 to a negative beta, as displayed in Exhibit 1. The negative Equity beta means bad news for the stock market is good news for Zoom, as the company’s “revenues presumably expand when more people work remotely.” ³

Exhibit 1: Zoom’s Rolling 63 Day (1 Quarter) Beta Relative to Venn’s Equity Factor

Sources: Venn and Yahoo! Finance as of August 25, 2020. Time period: October 7, 2019 - July 31, 2020.

On the other side of this beta shift, stocks in historically perceived “safe-haven” sectors, such as Utilities and Real Estate saw their betas increase. For example, the “Shifting Risk” exhibit in the WSJ article shows the Utilities sector’s beta of ~0.3 in 2019 increased to ~1.1 during the pandemic, which is a fairly dramatic move. Utilities stocks might have been considered boring, safe, and relatively low risk before the pandemic for many reasons, including their low leverage to the economy ⁴, propensity to pay dividends, and ownership of regulated assets ⁵. However, as covered in our previous blog post “Five ‘Safe-Haven’ Assets and Their Performance During the COVID Market Crisis”, the pandemic-induced standstill of economic activity led to Utilities suffering more than the market and, as Matt Levine put it, presenting “a white-knuckled ride” ⁶ for investors. 

Finally, many sectors’ betas moved closer to one, due at least in part to beta compression around the precipitous market selloff in February and March.

Given these reported changes in stock betas, we were curious to see how this may have impacted Venn's Low Risk factor over the YTD period.⁷ Beta is one of two key components (the other is Residual Volatility) of the Low Risk factor, which is a long/short, beta-neutral equity style factor that attempts to capture exposure to low-risk stocks by longing stocks with low betas and low residual return volatilities and shorting the opposite (login here to your Venn account for a deep dive of the factor or create a free Venn account). Given the Low Risk’s factor’s dependence on beta, we were interested to understand if there were any meaningful changes in the factor’s sector makeup, especially since the factor is not sector neutralized ⁸ (and can therefore freely establish sector tilts). In this report, we analyze the sectors’ weights in the Low Risk factor portfolio by aggregating the loadings ⁹ of stocks by sector. 

As mentioned earlier, the Low Risk factor is beta-neutral by construction. Because the factor is long low-beta stocks and short high-beta stocks, there would be a short beta bias in the factor portfolio if the factor were “dollar-neutral” (that is, if the factor allocated equal dollars to the long and short sides). Therefore, as expected, the factor has a net long bias (in dollar terms), which dropped meaningfully in the market crash in late February through March 2020, as stock betas converged to 1 (decreasing the beta imbalance of the long and short sides).

Exhibit 2: Low Risk Factor Long Bias (in dollars)

Source: Venn’s equity style factor data as of August 20, 2020. Time period: January 1, 2019 - July 31, 2020, using daily data.

Exhibit 3 shows the sector makeup of the factor’s long portfolio since the start of 2019. The sector composition was fairly consistent over this period of more than a year, but an inflection point that corresponds to the depths of the market drawdown in February and March 2020 shows the sector positions changing dramatically. The long positioning in Utilities and Real Estate declined, Information Technology and Health Care both entered the long portfolio (moving from the short portfolio, as seen in Exhibit 4), and Consumer Staples’ portion of the long portfolio grew.

Exhibit 3: Sector Composition of the Low Risk Factor's Long Portfolio Over Time

Source: Venn’s equity style factor data as of August 20, 2020. Time period: January 1, 2019 - July 31, 2020, using daily data.

The factor’s short portfolio has been more concentrated from a sector perspective. For all of 2019 through the beginning of this year, the sectors in the short portfolio were Information Technology, Health Care, and Energy. Again, we observe a dramatic shift around February and March 2020. Information Technology and Health Care abruptly moved to the long portfolio, as their relative betas and/or residual return volatility dropped. Energy and now Consumer Discretionary split the short portfolio.

Exhibit 4: Sector Composition of the Low Risk Factor's Short Portfolio Over Time

Source: Venn’s equity style factor data as of August 20, 2020. Time period: January 1, 2019 - July 31, 2020, using daily data.

To conclude, the pandemic has caused a major shift among the riskiness of various equity sectors. As a result, Venn’s Low Risk factor experienced a decrease in its net long exposure (in dollars) as stock betas converged, as well as a dramatic sector rotation. Increasing betas for stocks in historically perceived “safe-haven” sectors, such as Real Estate and Utilities, has resulted in those sectors receiving a declining weight in the Low Risk factor’s long portfolio. Additionally, falling betas for stocks in Information Technology and Health Care caused those sectors to shift from the factor’s short portfolio to the long portfolio. 

REFERENCES

¹ Source: Matt Levine’s “Money Stuff: People Loved Nikola But Not Its Warrants” on July 21, 2020 (see “Betas” section).

² Beta represents the return sensitivity of a stock relative to the overall equity market, which can be proxied by some broad equity index like the MSCI ACWI or S&P 500. For example, if a stock exhibited a beta of 1.2 relative to the S&P 500, that means that for every 1% the S&P 500 returned, the stock returned 1.2%, on average.

³ Source: CFA Institute blog post “Stocks Turned Upside Down? The COVID-19 Beta Effect” on July 14, 2020.

⁴ Source: Matt Levine’s “Money Stuff: People Loved Nikola But Not Its Warrants” on July 21, 2020 (see “Betas” section).

⁵ Source: Frontier Economics article “Have utilities caught the risk bug?”

⁶ Source: Matt Levine’s “Money Stuff: People Loved Nikola But Not Its Warrants” on July 21, 2020 (see “Betas” section).

⁷  The time period for this analysis is January 1, 2020 - July 20, 2020, using daily data.

⁸ None of Venn’s equity style factors is sector-neutralized. In our research, this design choice did not materially affect factor performance.

⁹ The loadings include various adjustments, such as stock liquidity adjustments (trading volume, volatility, etc.), beta neutrality adjustments, and region liquidity adjustments.

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