Before we jump into this week’s conclusion to our three-part beta series, I want to briefly veer back to an earlier topic I had covered during our recent macro series, which generated many positive comments and feedback from our readers. For those of you who would like to continue your macro explorations, I will be co-presenting at a joint webinar with Qontigo on June 23 alongside Qontigo’s Melissa Brown titled: Macro Matters, Even for Fundamental Managers. We anticipate a timely, deep-dive discussion with extensive Q&A, and I hope to see many of you there.

Our recent issues of Factor Spotlight have centered on the deteriorating efficacy of beta as a measure of market risk. One possible culprit is the increasing concentration in market-cap-weighted universes that represent key ingredients when deriving beta. The evidence showed a downward trend in the correlation of beta to the market that coincides very closely with market cap concentration. The charts below illustrate that as beta has decoupled from the market, the effective number of assets (our measure of concentration) has decreased as well, signaling that we may be able to tie increased market concentration to beta’s breakdown.

In our last Factor Spotlight, we delved into the recent behavior of beta to understand why this measure has been less useful in helping investors hedge market risk. We highlighted the apparent de-coupling of beta from the general market based on the decreasing correlation of the Beta factor return to the Market factor return using US and global equity risk models from Axioma and MSCI Barra.

Investors often look to good ol' beta as the tried and true mechanism for hedging market risk in their portfolios. However, many have noted that lately, beta feels “broken”.

Hedging beta no longer seems to have the desired effect of mitigating risk in portfolios, and in fact, investors who have tried to hedge beta in 2020 and 2021 will have found major headwinds as the beta factor took off on a wild ride in the post-COVID era.

If you want to hedge momentum, just go short Info-Tech and long Energy, correct?

Actually, not so fast.

This strategy may have been somewhat effective in prior markets; however in today’s market, the efficacy of this type of hedging strategy has been rapidly unraveling.

We can see this clearly by looking at the Momentum exposure, using the Wolfe Research QES US Broad risk model of QQQ vs. XLE.

Last week, we delved into ‘when’ macro matters by using the Axioma Macro Projection Model to identify historical periods when macro factors drove US equity volatility. This approach highlighted the Sovereign Debt Crisis in 2012 and the COVID market downturn as periods when macro factors became the leading contributors to volatility in the Russell 1000 Index. We also observed evidence of macro influence on performance during the COVID recovery period and uncovered Inflation as a critical rebound driver of equities in the past year.