Unlevered Beta

  

Categories: Derivatives

The beta of your portfolio of investments relates to how volatile that portfolio performs, relative to the overall market (the S&P 500).

Most hedge funds that live in a world measured by beta are, at times, extremely leveraged. That is, they have loads of debt on top of the equities they've purchased. So if a given portfolio was, say, 5:1 leverage, and it had $100 million of base equity, and that portfolio went up 10% with the market (i.e. they both went up 10% in 3 months), then the leveraged portfolio would have had $500 million total invested in the market, returning $50 million in gains...versus the levered $100 million, which would return just $10 million.

And yes, we're forgetting interest charges on that borrow. And yes, they'd likely be a lot. The idea is that, had the market gone the other direction, under all that leveraged-induced volume, the manager would be bust.

So levered and unlevered returns are calculated with the general vibe being that, if you have tons of leverage, you're adding gasoline to an already-smoldering fire. Hence, unlevered beta tries to put the risk gradients of all portfolios more or less on the same footing.

Related or Semi-related Video

Finance: What is Beta?22 Views

00:00

Finance allah shmoop What is beta it's Volatility That's it

00:07

here's a stock chart reflecting the performance of a highly

00:09

volatile stock plus size manikins ink and here's A teen

00:13

t stock chart The last twenty years Yeah Whole lot

00:16

less volatile Eighteen t stock has left beta then p

00:20

s m so here's p s m mapped over the

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s and p five hundred Gopi sm is about twice

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a cz volatile Is the market here like on days

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The markets up one percent p s m is up

00:31

two percent on days The markets down four percent p

00:33

s m is crushed down eight percent So you'd say

00:36

it has a beta relative to the s and p

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five hundred of two point Oh or two acts So

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the hammer this home let's do advanced math here So

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if any given day the marks up one point two

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percent has bit of two point Oh you'd expect p

00:48

s m to be up two point four percent and

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same deal on the downside Yeah All right So what

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gives a company high beta Well simply put uncertainty Some

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companies have products in the pipeline Where the broader market

01:00

has a lack of certainty that buyers by the millions

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anyway will want that product sort of the opposite of

01:07

coca cola Like what are the odds that buyers will

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still want diet coke next year Yeah pretty good odds

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but plastic manikins modeling extra large kimonos away Less certainty

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So the company may end up awesome and ruling the

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world Or it may end up being melted down for

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spare parts Yeah Making newsman drone helicopter thing right Well

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what else creates beta Well leverage or debt Some companies

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have tons of cash Others have tons of debt of

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company a is trading for one hundred bucks a share

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and it has no debt and ninety five dollars a

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share in cash Will The market is valuing the operations

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of that company and only five bucks a share So

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the operations could do awesome Or they could do terrible

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and nobody's going to care Big web stock goes to

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one hundred hundred five Ninety five Something like that big

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No big deal So yeah i think about that The

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value The operations could increase one hundred percent and be

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worth five dollars more than the company's worth one hundred

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Five bucks No big deal All right but what about

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company b It has one hundred million box in ibadan

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or cash flow or cash earnings and five hundred million

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dollars in debt Well it trade today at eight times

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ebitda calculated as eight times that hundred million figure Then

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subtracting the five hundred million dollars in debt Well the

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company would be valued at three hundred million dollars That

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would be its market cap But what if it's new

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product is likely to be loved and people get excited

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about it and its operation suddenly get valued at twelve

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times even thought instead of just eight While the math

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goes like twelve times than one hundred million in cash

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flow for one point two billion then you subtract the

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five hundred million dollars in debt And that gets you

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a market value for the whole company of seven hundred

02:48

million dollars So think about it The multiple of even

02:50

da being paid by investors went up just fifty percent

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from eight to twelve But the stock market value of

02:56

this company went up well over one hundred per cent

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In fact one hundred thirty three percent Why so much

03:01

More volatile or so much more beta Yeah leveraged debt

03:04

gasoline on the fire It can be great but when

03:08

things go the other way it can leave you feeling 00:03:10.49 --> [endTime] you know like a dummy

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