Some investors are prohibited from using leverage, and other investors’ leverage is limited by margin requirements. Therefore, they over-weigh risky assets instead of using leverage, which makes these assets more expensive. High-beta and risky assets should, therefore, deliver lower risk-adjusted returns than low-beta assets. Investors could exploit this inefficiency by using ETFs (or futures) by “betting against beta”, i.e., by going long on a portfolio of low-beta countries (leveraged to a beta of 1) and short on a portfolio of high-beta countries (de-leveraged to a beta of 1). Research also shows this effect isn’t limited to country equity indices and stocks but also works well in other asset classes (even between asset classes).
The reason for the anomaly functionality was already stated in the short description – a lot of the investors are prohibited from using leverage, and their only way to achieve higher returns is to buy more risky stocks, which is the main cause for their overvaluation. Investors not facing these constraints could earn above-average returns by exploiting this phenomenon.
Confidence in anomaly's validity
Backtest period from source paper
Notes to Confidence in Anomaly's Validity
Period of Rebalancing
Notes to Indicative Performance
per annum, annualized monthly return (geometrically) of 0.78% (from table IX – return for long short portfolio)
Notes to Period of Rebalancing
Number of Traded Instruments
Notes to Estimated Volatility
Notes to Number of Traded Instruments
data from source paper from table 2, it is up to investor how many countries he/she would like to use
Notes to Maximum drawdown
Notes to Complexity Evaluation
Simple trading strategy
The investment universe consists of all country ETFs. The beta for each country is calculated with respect to the MSCI US Equity Index using a 1-year rolling window. ETFs are then ranked in ascending order based on their estimated beta. The ranked ETFs are assigned to one of two portfolios: low beta and high beta. Securities are weighted by the ranked betas, and the portfolios are rebalanced every calendar month. Both portfolios are rescaled to have a beta of one at portfolio formation. The “Betting-Against-Beta” is the zero-cost zero-beta portfolio that is long on the low-beta portfolio and that shorts the high-beta portfolio. There are a lot of simple modifications (like going long on the bottom beta decile and short on the top beta decile), which could probably improve the strategy’s performance.
Hedge for stocks during bear markets
Partially - Low beta stocks and countries are usually safer during turmoil, and Beta Factor in Country Equity Indexes in a long-short variant can be used as a portfolio hedge against equity risk. However, caution should be used as the popularity of betting-against-beta investing could move valuation (measured by common valuation ratios like P/E, P/B, P/CF, etc.) of low beta countries into excessive-high (compared to neutral market valuation). This popularity of betting-against-beta factor investing and the high valuation of low beta countries can be then detrimental to their performance during market stress.
Strategy's implementation in QuantConnect's framework