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Portfolio > Portfolio Construction

Total Beta

By Richard Hoe

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I am indebted to reader Wayne Lebouef, an advisor in Florida with Money Concepts, for asking about my “Total Beta” theory, which appeared my “The Investment Edge” column in the July issue of Life Insurance Selling. This is my response to Wayne’s question:

When I wrote the column that referenced beta, I mentioned that I had fooled around with trying to come up with an idea about Total Beta (TB), a concept to encompass a combination of VIX (the volatility index) and beta and apply a combination of the two to an individual investment, fund or portfolio.

I got caught-up with VIX, which changes so constantly that it is difficult to pinpoint a frame of reference. I don’t think I’m the first person to attempt this mixture of beta and other risk quotients. TB could be applied minute-by-minute by frequent traders, along with other fundamental, technical or momentum analysis, to aid in making decisions. My problem is that I’m far from being a frequent trader, and I use metrics as an important part of portfolio building. Since modern portfolio theory is now suspect (using MPT, I came through the March 2000 to March 2003 debacle very well, but it did not have as good an outcome in 2008 and we now know may sometimes apparently go upside-down when black swans occur), I think we all may want to add the word “tactical” to our portfolios.

The beta computed by Morningstar and other database operators is based on historical averages for months, years or even a decade; therefore it seems logical that we could use averages for VIX and combine the two into a formula for purposes of portfolio development.

We use beta as a more or less static marker; it does tend to be more stable by far than VIX. I guess if we can use average beta, we can probably use average VIX, which argues that there may be a place for TB. But where beta for a fund or investment may not change from its mean rapidly or often, VIX is a hummer and may change significantly in short time spans (looks almost like a pun — the volatility index is volatile!). TB may ultimately be a tool, and I promise to keep thinking about it, despite my math challenges. I do think, if and when developed, TB would need to be applied to an investment (or portfolio) frequently to have value. Maybe it is a possible key to applying a tactical tool to a static portfolio.

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