This question is to test your fundamental understanding of beta neutral investing. Beta neutral investing is common among hedge funds including Citadel, Point72, MILLENNIUM and UBS O’Connor, which run equity portfolios that has an overall weighted beta of close to 0. Having a PORTFOLIO beta of NEAR 0 would neutralize the portfolio’s exposure to the market. Prominent long/short funds mentioned above are famous for generating returns with the beta neutral strategy over the years regardless of how the S&P has performed.

The beta of a stock measures how it moves relative to the market, and here are 2 straightforward points to remember about beta.

Beta has two components:

Magnitude: If a stock has beta of 1.2, it means the stock is 20% more volatile than the market. For example, if the S&P moves up 10% over a year, the stock would’ve moved up 12%. If a stock’s beta is 0.8, it is 20% less volatile than the benchmark.

Direction: The beta can be either positive or negative. If the stock’s beta is negative, it means the stock is “counter-cyclical” – the stock moves against the market. You can find stocks with negative beta in industries that hold up well in difficult economic times, such as consumer staples and basic metals (gold & silver).

Beta is very useful in hedging. In building a beta neutral portfolio, you want to short a basket of stocks to offset your long positions, which would create a portfolio with beta close to 0.

Here’s an example: Let’s say you are excited about the company-specific prospect of Coca-Cola (KO) and would like to long the stock, but you’d like to hedge out the market exposure. You can neutralize the position by shorting Pepsi (PEP), since they are in the same industry and share similar betas. This is the basic idea behind long/short investing.

This question is to test your fundamental understanding of beta neutral investing. Beta neutral investing is common among hedge funds including Citadel, Point72, Millennium and UBS O’Connor, which run equity portfolios that has an overall weighted beta of close to 0. Having a portfolio beta of near 0 would neutralize the portfolio’s exposure to the market. Prominent long/short funds mentioned above are famous for generating returns with the beta neutral strategy over the years regardless of how the S&P has performed.

The beta of a stock measures how it moves relative to the market, and here are 2 straightforward points to remember about beta.

Beta has two components:

Magnitude: If a stock has beta of 1.2, it means the stock is 20% more volatile than the market. For example, if the S&P moves up 10% over a year, the stock would’ve moved up 12%. If a stock’s beta is 0.8, it is 20% less volatile than the benchmark.

Direction: The beta can be either positive or negative. If the stock’s beta is negative, it means the stock is “counter-cyclical” – the stock moves against the market. You can find stocks with negative beta in industries that hold up well in difficult economic times, such as consumer staples and basic metals (gold & silver).

Beta is very useful in hedging. In building a beta neutral portfolio, you want to short a basket of stocks to offset your long positions, which would create a portfolio with beta close to 0.

Here’s an example: Let’s say you are excited about the company-specific prospect of Coca-Cola (KO) and would like to long the stock, but you’d like to hedge out the market exposure. You can neutralize the position by shorting Pepsi (PEP), since they are in the same industry and share similar betas. This is the basic idea behind long/short investing.