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 Modern Portfolio Theory...4 Views
Finance allah shmoop what is modern portfolio theory All right
basic idea Here people Diversification is good Dig it right
C d i g there that's modern Alright let's goto
a gn modern like when hunk and invested from their
cave Well they just invested in good rocks or spears
and really didn't worry about much else And well math
hadn't really been invented yet So like who knew that
If all right well then along came harry markowitz in
nineteen fifty two who tried to science and math the
crap out of the stock market What he came up
with was modern portfolio theory which basically said that there
was a smarter way to invest than just you know
putting your life savings into blockbuster because you like the
logo using all sorts of advanced metrics that we won't
torture you with here The theory he devised was that
well rather than throwing your money against the wall to
see what sticks you could use extensive elaborate data to
determine the best way to maximize your returns depending on
how much risk you were willing Teo you know risk
And there are five key ideas behind modern portfolio theory
And yes of course we have videos on each of
these The first is alfa which is kind of like
how smart you are in the market Then there's beta
which is about volatility in a broadway The vics we
got a whole video set on that Then they're standard
deviation and no that's not some kinky reference to fifty
shades It's more about how the market diverges from your
given individual stock pick and volatile things are finally the
beta then there's our squared it's all about how a
stock or a given index conforms to a given line
or expected return ratio Like how close it is how
proximate is And then finally you have the sharpe ratio
Thank you bill sharp from stanford university who also talked
about being smart in the market so that you could
evaluate your rich turns whether they were smart or just
a lottery ticket Lucky Oh and we're probably not such
a wise investment in the beginning even though they turned
out okay That would be sort of the sharpe ratio
Yeah all right Well in general mpt skews toward less
risky investments but it all comes down to risk reward
Tolerance in the end if for whatever reason you feel
supremely confident that radio shack is about to make a
massive come back well you might be able to justify
taking more risk in loading the dice But to be
clear radio shack was just a bad example So kids 00:02:33.29 --> [endTime] don't try this at home
Up Next
What is Beta? Beta is a figure associated with public companies that measures how risky the company’s stock is in comparison to the market as a w...
Misappropriation. Misrepresentation. Miss Independent. Yeah... we'll get into all the Little Misses here. (Hint: "mis" = "bad")
