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Duration: 5:03

Instructor:

Contributor: Interactive Brokers

Level: Intermediate

In this short video, you will see the impact on a stock portfolio from a shift in an underlying benchmark index. The aim of this video is to view contrasting impacts between an Equal Weighted portfolio and a Beta Weighted portfolio.

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Study Notes:

In this short video, you will see the impact on a stock portfolio from a shift in an underlying benchmark index. The aim of this video is to view contrasting impacts between an Equal Weighted portfolio and a Beta Weighted portfolio.

Beta measures the sensitivity of a security to an underlying benchmark such as a stock index, while calculations are made from daily returns over the past two-years. Stocks that are sensitive to the performance of the reference benchmark have a high Beta, while stocks that move relatively less have a low Beta.

Using the IB Risk Navigator, from the Metrics menu under the Beta Risk elements select Beta, Weight and Weighted Beta adding them to the display. In this portfolio of stocks you can see the dollar amount invested is approximately equal.

To change the chosen reference index, use the Settings menu and select from available items in the Beta Reference index selector. In this case I am using the S&P 500 index. By displaying the portfolio according to a high-to-low Beta sort, you will also be able to contrast the dollar weight to the Weighted Beta reading. To sort, simply click on the Beta column-header so that it displays a red arrow pointing downwards.

The raw Beta reading describes the under or over-performance of the stock to the index. A Beta of 1.0 implies that the stock moves exactly in line with the index. More specifically, the stock’s return historically is the same as the return of the index.

A stock with a beta of 2.0 both rises and falls with two-times the return of the index. A Beta reading of 0.5 infers that the stock rises or falls at half the return of the index over time.

Higher Beta stocks carry greater weight in the portfolio. You can view the expected change in the value of your portfolio from the plot viewer selecting either Beta Weighted or Equal Percentage Move Aggregation.

The Equal Percentage method will calculate the expected impact on the Portfolio should the reference index move up or down, using the Weight of each stock.

By contrast, the Beta Weighting method projects expected profit and loss given the composition of stocks and their historic performance relative to the benchmark.

We can review this concept by looking at a portfolio of two stocks – Microsoft and IBM. Note that it is possible to edit the Beta value by simply typing your own value in each field under the beta column. Red-font denotes user-input values, while black-font shows system-generated Betas. By assigning a 0.5 Beta for IBM and a 1.5 Beta value for Microsoft, we can contrast the impact on a portfolio and at the individual level for both Equal-weighted and Beta-weighted measures.

We can contrast what happens under each scenario. For the Equal Weight portfolio, the IB Risk Navigator assumes a synchronous increase of 10% for both MSFT and IBM. The Beta-weighted portfolio value change assumes that each stock rose according to its Beta, such that IBM added 5% for a 10% gain in the index, while MSFT rose by 15% for the same change in the reference benchmark.

Understanding these alternate methods for portfolio monitoring purposes is important to risk managers. An equal-weighted plot most accurately represents occasions when the market moves as a whole, such as during a large market dislocation. A beta-weighted plot better reflects the day-to-day statistical variation of the market prices.

Finally, you may change the time period of beta calculation, whose default time period is the last two years. Access from the Edit dropdown menu and select from choices of either Custom or Date Interval range. The Custom Horizon allows users to determine the number of years, months or days. The Date Interval allows users to select specific Start and End Dates. Each allows users to drive the calculation using daily, weekly or monthly computations.

Disclosure: Interactive Brokers

The analysis in this material is provided for information only and is not and should not be construed as an offer to sell or the solicitation of an offer to buy any security. To the extent that this material discusses general market activity, industry or sector trends or other broad-based economic or political conditions, it should not be construed as research or investment advice. To the extent that it includes references to specific securities, commodities, currencies, or other instruments, those references do not constitute a recommendation by IBKR to buy, sell or hold such investments. This material does not and is not intended to take into account the particular financial conditions, investment objectives or requirements of individual customers. Before acting on this material, you should consider whether it is suitable for your particular circumstances and, as necessary, seek professional advice.

Supporting documentation for any claims and statistical information will be provided upon request.

Any stock, options or futures symbols displayed are for illustrative purposes only and are not intended to portray recommendations.

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