Generations of investors have been told that risk and reward go hand-in-hand, so given the extreme volatility of high beta’s performance one would think that investors have been compensated for this risk. In years in which the markets were positive, high beta investors generally were compensated for this higher risk, capturing, on average, 138% of the market’s return. However, in down years for the market, high beta investors got clobbered, suffering declines that were, on average, roughly 243% of the market’s decline. As a result, the riskier portfolio actually underperformed the market as well as, paradoxically, the low-volatility portfolio:
A very good explanation for this paradox of higher risk and lower returns from high beta stocks comes from Cliff Asness of AQR, who wrote a detailed paper on the subject. In simple terms, Cliff and his team found that leverage constraints cause investors to bid up the prices of these lottery-type stocks, ballooning their valuations, and reducing their prospective returns.
In sum, investors who find themselves behind on savings goals might be tempted by the allure of high beta stocks, hoping to make up for lost time by betting on magnified outcomes. However, experience has shown that this is unwise, often leaving investors worse off than they might otherwise be.