One of the more fascinating theories in behavioral finance is the “theory of leverage aversion,” which, simply put, is the notion that investors who cannot or do not wish to add leverage to their portfolios (in order to magnify returns) instead do the next best thing, which is to load up on stocks with high beta.  In rough terms, a high beta stock is one with higher-than-average volatility than the overall stock market, but also therefore a higher chance of outperforming the market by delivering outsized returns, something researchers have come to call “lottery stocks.”

We can see from the last few decades of returns that high beta stocks (as defined by the S&P 500 High Beta index) have tended to produce these lottery-type outcomes, with strong outperformance in many up years, but also with steep underperformance in several years:

Another way to view the effect of high beta is with a distribution of annual returns.  Over the last twenty-seven years, the high-beta portfolio has generated the widest dispersion of outcomes, with a couple of extreme outlier years in both up and down markets.  Conversely, both the overall market and high-beta’s counterpart, low-volatility, have produced a far narrower range of outcomes: