Low beta stocks: wither protection

Written by Rahul Jain | Rajesh Naidu | Updated: Jan 27 2008, 06:08am hrs
Markets have been very destructively volatile in this week, hitting a lower circuit of 10% twice on the first two trading days. Not to mention the continuous fall of the benchmark index for five consecutive days in the week before the last one. There is more to this, as foreign institutional investors (FIIs), who are the trigger for the market have turned net sellers in this week, removing more than Rs 12,000 crore from the market.

This sucking out of the money from the market is looming large, and its heat is felt in the more downside risk, as the total turnover in both the exchanges including cash, derivatives has gone down drastically. On the day of the biggest fall in the Sensex, the markets saw a total turnover of Rs 11,5000 crore. On the subsequent day, the volume drop by more than 40% to Rs 60,000 crore. So, the biggest question is how much the market can sustain itself on the backdrop of lower volumes.

This fall has been worse for mid-cap and small-cap companies. Some stocks have declined by more than 30%, while most of the stocks have seen a fall of more than 10%. This fall was in the companies, which had seen a rapid run up in the last year. However, these are companies that gave lower returns and some of them were one-year lows. They are fundamentally strong and have a proven past record, available at a price almost at par or slightly higher than their book value and also give decent dividend yield in the range of 3-6% per annum. These companies', which fall into this category, are known as defensive stocks.

These stocks can't deliver higher returns for you, but will act as a cushion and insulation to your portfolio. Getting an exposure to these stocks would have been a prudent and wise decision, had you picked up them during the mayhem. However, it is never too late when it comes to equity and the lucrative element associated with it. Here is an analysis of the performance of low-beta (coefficient) stocks, and what such a parameter as beta (coefficient) signifies and what you as an investor must keep in mind while choosing stocks that are low on beta.

Alpha and omega

One reason for limited downside risk in the markets is that there are stocks, which are year or all time low and there is strong support at lower levels. Some companies in the Pharma and FMCG sector could fall into the defensive category. These sectors have been under-performers due to lower or declining growth. Defensive ones can also be termed as low beta stocks. Beta coefficient is a measure of a stock volatility in relation to the rest of the market. If the beta is 1, it means that 10% in the market will bring 10% increase in the stock and vice versa. Some scrips have negative beta.

This means 10% rise in the market will give negative returns and vice versa. Investing in low beta doesn't mean that it's a good investment for higher returns. Also, one point to note is that beta is never constant. The stock having a beta of 0.5 may not be the same after one month or so. As the time passes, the stocks that were low on beta may become high on beta. So low beta implies lower risk and vice versa.

For your use

Beta as a parameter is taken because risks are of two types: systematic and unsystematic. An unsystematic risk is industry specific, while a systematic risk is dependent on an overall market situation. If the market declines, it is obvious that the stock, which is a part of the market, should decline.

But how much it declines depends upon the price at which it is available. If the stock declines relatively lower than other stocks, it is said to be good as the downside risk is lower. Beta is the measure for ascertaining this relationship between a particular stock and the overall market. Here the benchmark index is the Sensex.

Every investor looks at overall portfolio returns and if the market tumbles down in a very short time, then the portfolio value plummets instantly and shaves off the notional gains. On the other hand, if the investor has low beta stocks in its portfolio, then it acts as insulation and protects it from a higher downside. The equity market will continue to be in a bearish phase ahead warns one of the independent technical analysts. And it is this point you should be wary of.

Just that the stock has a low beta doesn't mean that it is fundamentally strong. Before increasing your exposure in low beta stocks, first look at the financials and the past track record with the sector performance.

You must have low beta high dividend yield stocks, which act as a cushion to your portfolio and stabilises your overall returns in case of a downward trend. It is recommended that you should liquidate the position in low beta ones, and increase your exposure in momentum or high growth stocks, when the market gathers strength and the upside is visible.

The above mentioned stocks have been sifted on the basis of on different paramenters and should not be construed as a recommendation