The heavy blow that growth investors experienced in 2018 came as a surprise as many relied on traditional calculations to determine risk exposure. However, by utilizing a more updated methodology, exchange traded fund investors may be better equipped to more accurately determine the amount of risk they are exposed to and potentially enhance their exposure to growth companies.
Traditional estimates of risk or beta are based on calculating long-term past performance such as through looking at a five-year period of monthly returns. On the other hand, Salt Financial looked at their patented truBeta methodology that incorporates more recent intraday data, multiple historical periods and a non-linear model to forecast beta over the next quarter.
“One of the benefits of this measure is the increased responsiveness to more recent moves in the market, which can potentially help with accuracy,” according to Salt Financial.
Tony Barchetto, Founder and Chief Investment Officer for Salt Financial LLC, compared the traditional beta to the company’s truBeta calculations and Q4 returns for various funds:
Table 1 – Selected Growth Equity Mutual Funds, Estimated Beta and Returns – Q4 2018
| Issuer/Fund | Ticker | Traditional Beta (9/30/2018) | truBeta™ (9/30/2018) | Q4 Return (12/31/2018) |
| American – Growth Fund of America | AGTHX | 0.99 | 1.15 | -15.1% |
| Fidelity – Growth Company Fund | FDGRX | 1.15 | 1.32 | -20.9% |
| Invesco – American Franchise Fund | VAFAX | 1.13 | 1.25 | -18.6% |
| T. Rowe Price – Blue Chip Growth Fund | TRBCX | 1.08 | 1.22 | -14.2% |
| JP Morgan Growth Advantage Fund | JGASX | 1.07 | 1.24 | -17.8% |
| Clearbridge Large Cap Growth Fund | SBLGX | 0.98 | 1.14 | -13.4% |
| SPDR S&P 500 ETF (Benchmark) | SPY | 1.00 | 1.00 | -13.5% |
Source: Bloomberg
Barchetto pointed out that the more forward looking truBeta estimates of market risk on September 30th were significantly higher than the more traditional historical measures, suggesting more market risk embedded in these funds than many would expect. This manifested itself in the returns for Q4, with all but one fund exceeding the decline in the S&P 500 by December 31st. For example, with a truBeta of 1.32, Fidelity’s Growth Company Fund would be expected to drop about 18% in response to a 13.5% move down in the S&P 500. It ended up falling about 21%–over one and a half times the loss in the S&P 500.
“The one factor CAPM is by no means perfect (other factors contribute to returns), but in this case the funds with the highest truBeta scores (above 1.20) all suffered bigger losses on the downside,” Barchetto said.
“The same dynamic also plays out on the upside. With a strong start for the S&P 500 so far in 2019, the funds with highest betas have notched the best returns (Fidelity’s Growth Company and JP Morgan’s Growth Advantage),” he added.
Barchetto argued that a more responsive measure like truBeta can potentially reveal sources of market risk that are less apparent using more traditional measures of risk. Additionally, the juiced-up beta in these funds raises questions on exactly what an investor is paying for – is it stock picking or just over-loading the portfolio with beta to shoot for higher average returns? If it’s the latter, there are likely cheaper, index-based vehicles for targeting higher beta stocks for more aggressive portfolio allocations.
For example, Salt Financial has come out with their own ETF to put their strategy to the test. The Salt High truBeta US Market (SLT), seeks to track the investment results of The Salt High truBeta US Market Index, which provides exposure to higher beta US stocks based on the truBeta forecasts of market sensitivity. Additionally, SLT comes with a relatively cheaper 0.29% expense ratio, compared to the average expense ratio on the active mutual funds listed above at 0.89%.
To read the full research piece, Are you paying for stock picking or super-sizing your beta?, visit Salt Financial.