What is Negative Beta?

what industries, products, etc have negative betas? i know gold is one, but what else and why?

Can Beta Be Negative?

Yes, beta can be negative.

As defined by the WSO Finance Dictionary:

Beta shows the performance of an asset relative to the market, i.e. an asset with a beta of 2 will always perform double that of the market (10% market rise = 20% asset rise, 5% market fall = 10% asset fall).

Therefore, if a stock always falls 10% while the market is rising 10% a company would have a negative beta of 1 because it falls by the same amount that the market rises.

Check out a video of how to interpret beta below.

Negative Beta Stocks and Industries

Gold is the most widely used example as something with negative beta. Gold has an inverse relationship with the market. When markets are in turmoil, investors (at least in theory) turn to gold.

User @smuguy97", a private equity associate, shared some examples of industries with negative betas:

“smuguy97 – Private Equity Associate”:
Industries that have negative betas demonstrate counter cyclical movements with the market as a whole. On a basic level, try to think about industries or subsegments that would benefit from a broad deterioration in the economy.

A couple examples:

  • Bankruptcy advisory services - this one is pretty obvious, a weaker economy = more bankruptcies
  • Career colleges / trade schools - when unemployment is high, people without jobs go back to school
  • Gold is actually a bit different, but broadly speaking, the price of gold increases in times of financial duress because this is when capital moves out of riskier investments (e.g., junk bonds), thus depressing their prices, and into higher quality investments (e.g., gold).

Read More About Beta on WSO

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gold's pretty much all I could find.  You can go to finance.yahoo.com and use their stock screener to search for actual stocks with negative beta (even though this isn't the best stock screener it works) and they have negative beta's because when the market goes down, gold typically rises because people see it as a safe alternative (i'm guessing due to its implicit value...its GOLD) 

 

Industries that have negative betas demonstrate counter cyclical movements with the market as a whole. On a basic level, try to think about industries or subsegments that would benefit from a broad deterioration in the economy. A couple examples:

Bankruptcy advisory services - this one is pretty obvious, a weaker economy = more bankruptcies

Career colleges / trade schools - when unemployment is high, people without jobs go back to school

Gold is actually a bit different, but broadly speaking, the price of gold increases in times of financial duress because this is when capital moves out of riskier investments (e.g., junk bonds), thus depressing their prices, and into higher quality investments (e.g., gold).

 

debt is always senior to equity is the right answer... if there is a negative beta and the equity market risk premium is relatively high, then there'd be a negative cost of equity, which is impossible. Yes its true that a company with a negative beta will have a low cost of equity, but debt will always be lower, it has to because there is always less risk with debt... did the 1st guy ask you if this were possible if there were a negative beta, or did he tell you this

 

Okay, that's what I thought - and said the first time.

The first guy definitely told me that it was possible with a negative beta. I was stumped and told him I couldn't think of any situations... So it was essentially a "you got that wrong, but here's the correct answer" type of thing...

That's frustrating. I basically got marked wrong on this twice, which doesn't seem fair at all. Oh well.

 

No, the first guy was right. Here’s why: A (rational) investor is only concerned about the risk of his portfolio. Adding the negative beta stock reduces his portfolio risk. He will accept a lower return for the equity.

Is the stand alone risk of the equity greater than that of the debt? Yes (due to seniority) but that is not the appropriate way to analyze investments.

 

There are a lot of assumptions going on here, particularly that CAPM is the correct model to use in all cases (least of all when Beta is negative).

Hypothetically, if we assume CAPM is a valid model, the required return on equity for a negative beta stock could be negative. I would think about it this way, essentially you would be paying for insurance... a form of hedging. In that theoretical case, the cost of equity would be less than cost of debt, simply because credit risk cannot be negative.

Does that make sense though in the context of reality? I'm not positive. But using the assumption of CAPM anything is possible lol.

Jack: They’re all former investment bankers who were laid off from that economic crisis that Nancy Pelosi caused. They have zero real world skills, but God they work hard. -30 Rock
 

Well, the logic behind this assumption (that cost of equity can be lower than the cost of debt) is not contigent on the specific asset pricing model that is used (CAPM in this case).

This whole thing revolves, as Damodaran pointed out, around the notion that if you have an investment that contributes to LOWERING the overall risk of your "asset portfolio," you'll be willing to accept a lower return on that investment. "Paying for insurance" as Revsly mentioned.

If you accept and use CAPM as your pricing model, the beta coefficient will give you the correct measure of an investment's contribution risk. If you use a different pricing model (multifactor, ABT, etc), you will still come to the same conclusion as with the CAPM, but just with other measures of contribution risk.

However, what all these asset pricing models and Damodaran's logic have in common is the notion of the marginal investor holding a well diversified portfolio (modern portfolio theory) and contribution risk being the correct measure of an asset's risk.

So would anyone hold a negative return stock in a single-stock-portfolio? Of course not, since the idea of beta and contribution risk would no longer apply and you would no longer have anything to "insure" as mentioned above.

 

@righton - your explanation makes a lot of sense when I read it, but I'm just wondering, is there any situation where we should consider this question from a standalone perspective, rather than thinking about risk as being defined as the contribution to overall portfolio risk.

I'm asking because a lot of times in finance classes, we just talk about cost of debt and equity in terms of the required rate of return that an investor in a company would demand to compensate them for the risk taken. Since debt is senior to equity, equity holders are taking on more risk and thus would demand a higher rate of return as compensation.

I'm not sure how to connect these two lines of thought together? Are you saying that if beta is negative, by investing in this company, equity holders are actually lowering their overall risk profile, whereas debt holders are increasing their risk profile (because we assume debt beta is positive)?

Would appreciate your thoughts!

 

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