When researching stocks for investment, stock analysts are always looking at what’s known as beta values, in order to measure the risk associated with the stocks. Beta measures the volatility of a stock compared with the volatility of the market as a whole i.e. it shows how often a stock’s price appears to fluctuate up and down with regard to other stocks. A high beta means that the stock price is more sensitive to market news and information and will move faster than a low beta stock. In general, high beta means high volatility or risk, but also offers the possibility of high returns if the stock turns out to be a good investment. 

Let’s assume the beta value, as calculated by an index, of the entire stock market is 1.  A stock with a beta value of 1 will see its price move with that of the index. Investors with a low  tolerance for volatility or a low appetite for risk will be happier with a stock having a beta value of 1 or lower. An investment with zero beta means no volatility and no risk. The cash in your wallet also has zero beta: The value of a 1 rupee coin will always be 1 rupee, and carries no risk of a fluctuation in value. Of course, inflation erodes money’s buying power, meaning that if zero-beta investment pays interest at less than the rate of inflation, the investment essentially loses.

On the other hand, a negative beta coefficient means an investment which moves from the stock market in the opposite direction. As the market moves upwards, the negative beta investment usually drops. And when the market falls, then the negative-beta investment tends to rise.

The reason negative betas pose a conundrum to many finance enthusiasts is that they seem to go against intuition. Negative beta is an unusual concept in the stock market. After all, if an average risk is a beta of 1 and a beta of 0 is risk-free, how would an investment be at negative risk?

The answer is here. Yes, beta can be negative. To see how and why, consider what beta measurements are: the risk added to a well-diversified portfolio by an investment. By that description, any investment that makes the total risk of the portfolio go down when applied to a portfolio has a negative beta. A more intuitive way of thinking about this is that a negative beta investment acts as an insurance against certain macro-economic risks that adversely affects the rest of your portfolio constitutes.

Furthermore, a negative beta coefficient does not necessarily mean absence of risk. 

Instead, negative beta means your investment provides a hedge against significant market downturns. However, if the market continues to grow, a negative beta investment loses money through opportunity risk, the lack of the opportunity to make higher returns, and inflation risk, in which a low rate of return does not keep pace with inflation. As the stock market has historically produced a positive return in most years, the mere act of investing in negative-or low-beta stocks increases these risks over time.

A standard example that is offered for a negative beta investment is gold stocks and gold bullion, which acts as a hedge against higher inflation (which devastates financial investments such as stocks and bonds). Also, since gold is perceived as a more secure store of value than currency, a market downturn prompts investors to sell their stocks and either move into cash (for zero beta) or buy gold (for negative beta).  Puts on stocks and selling forward contracts against indices will also tend to have negative betas. However, even assets that, in theory, could have negative betas (gold, for instance) seem to have positive betas when securitized (gold shares, gold ETF). The securitization process seems to make real assets behave more like financial assets.

So now the question is, are there actual investments out there that have negative betas?

To answer this question, I would like to quote Prof. Jayanth R. Varma, professor of finance at IIMA :

“My standard answer has been that negative beta stocks are a theoretical possibility but possibly non existent in practice. Every time I have found a negative beta in practice, there was either a data error or the sample size was too small for the negative beta to be statistically significant. I would also often joke that a bankruptcy law firm would possibly have a negative beta, but fortunately or unfortunately, such firms are typically not listed.”

However, now there is an interesting real life case of a negative beta stock: Zoom Video Communications, Inc. By market capitalization, this is not only a big company, but it is also a recognisable company with so many online classes taking place on Zoom. A reasonable discussion on why Zoom should have a negative beta has been going around during the Covid-19 pandemic. The argument is that if the pandemic rages, the economy crashes while Zoom stocks shoot up, and if the pandemic retreats, the economy recovers, and people go back to face to face meetings, and the Zoom boom is over.

This theory has been supported by the following data:

  • On March 13, 2020, the US declared Covid-19 to be a national emergency, a couple of days after the World Health Organization (WHO) declared it to be a global pandemic. From March 13, 2020 to June 30, 2020, Zoom has had a beta of -0.43, and it is statistically significant. All betas are relative to the S&P 500 index.
  • From the pre-pandemic days, this was a dramatic change. Zoom had a beta of 1.81 in the period from its IPO in April 2019 till the end of 2019. The high beta stock became a negative beta stock within a couple of weeks. 
  • More interestingly, once again, Zoom seems to be going back to a high positive beta stock. Using July 1, 2020 as a break point and it is obtained that its beta again becomes positive to 2.66.

It would be difficult to find a better example of beta changing this dramatically (going from around two to negative and then back to around two) within a couple of months without any change in the company’s business mix. Negative betas are probably a once in a 100-year event (the last global pandemic of comparable severity was in 1918), but the Zoom example illustrates the importance of estimating betas more carefully.

What are the consequences of a negative beta? 

The expected return on that investment will be less than the risk-free rate because it hedges the risk of the portfolio and one has to pay for this hedging benefit. Therefore, negative-beta stocks could be particularly appealing in a recession or a market downturn as stocks with negative betas are expected to move inversely to the broader market.

References :

  1. https://www.morningstar.in/posts/36419/can-beta-be-negative.aspx
  2. https://finance.zacks.com/negative-beta-coefficient-risky-positive-stock-market-7596.html
  3. https://jrvarma.wordpress.com/2020/08/23/negative-beta-stocks-the-case-of-zoom/

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