Zero-Beta Portfolio

What Is a Zero-Beta Portfolio?

A zero-beta portfolio is a portfolio built to have zero systematic risk, or all in all, a beta of zero. A zero-beta portfolio would have a similar expected return as the risk-free rate. Such a portfolio would have zero correlation with market movements, given that its expected return equals the risk-free rate or a moderately low rate of return compared to higher-beta portfolios.

A zero-beta portfolio is very far-fetched to draw in investor interest in bull markets, since such a portfolio has no market exposure and would in this way underperform a diversified market portfolio. It might draw in some interest during a bear market, however investors are probably going to address whether only investing in risk-free, short-term treasuries is a better and less expensive alternative to a zero-cost portfolio.

Figuring out Zero-Beta Portfolios

Beta and Formula

Beta measures a stock's (or other security's) sensitivity to a price movement of an explicitly referred to market index. This statistic measures assuming that the investment is pretty much unpredictable compared to the market index it is being measured against.

A beta of more than one demonstrates that the investment is more unstable than the market, while a beta short of what one shows the investment is less unpredictable than the market. Negative betas are conceivable and show that the investment moves in a contrary heading than the specific market measure.

For instance, envision a huge cap stock. It's conceivable that this stock could have a beta of 0.97 versus the Standard and Poor's (S&P) 500 index (a huge cap stock index) while at the same time having a beta of 0.7 versus the Russell 2000 index (a small-cap stock index). Simultaneously, it very well may be conceivable the company would have a negative beta to an exceptionally unrelated index, for example, an emerging market debt index.

The formula for beta is:

Beta = Covariance of Market Return with Stock Return/Variance of Market Return

A Simple Zero-Beta Example

As a simple illustration of a zero-beta portfolio, think about the following. A portfolio manager needs to develop a zero-beta portfolio versus the S&P 500 index. The manager has $5 million to invest and is thinking about the following investment decisions:

Stock 1: has a beta of 0.95
Stock 2: has a beta of 0.55
Bond 1: has a beta of 0.2
Bond 2: has a beta of - 0.5
Ware 1: has a beta of - 0.8

In the event that the investment manager allocated capital in the following manner, he would make a portfolio with a beta of roughly zero:

Stock 1: $700,000 (14% of the portfolio; a weighted-beta of 0.133)
Stock 2: $1,400,000 (28% of the portfolio; a weighted-beta of 0.154)
Bond 1: $400,000 (8% of the portfolio; a weighted-beta of 0.016)
Bond 2: $1 million (20% of the portfolio; a weighted-beta of - 0.1)
Ware 1: $1.5 million (30% of the portfolio; a weighted-beta of - 0.24)

This portfolio would have a beta of - 0.037, which would be viewed as a close to zero beta portfolio.

Features

Zero-beta portfolios have no market exposure so are probably not going to draw in investor interest in bull markets, since such portfolios would underperform diversified market portfolios.
A zero-beta portfolio is developed to have zero systematic risk — a beta of zero.
Beta measures an investment's sensitivity to a price movement of an explicitly referred to market index.