[MUSIC] Learning outcomes, after watching this video, you will be able to implement the betting against beta strategy. [MUSIC] Let's continue with the betting against beta strategy. So the paper is very complicated. That's why I keep telling students that these papers have a lot of entry barriers, so it's difficult to read the paper. It's quite complicated and technical, but the strategy that comes from the paper is very simple. So if you follow the process that we explained at the beginning of this course, then it's going to be fairly easy. So I have taken you through the abstract, and simple strategy, the idea is very simple. There are stocks with high beta and low beta and a lot of times these high beta stocks are more valued. Constrained investors beat their prices up, and there is your opportunity. So our trading strategy where you're short on high beta stocks and long on low beta stocks is likely to make money. Now this is strategy in a nutshell. Now we already seen how, we've discussed about this, it comes from CAPM. CAPM is a surprising model. Basically all that you ought to do is expect the return from a stock is risk free rate + Beta (MR- RFR). And Alpha is, your Alpha is, let say, Actual return- Expected return. So these two things are important in this strategy. So once you know, this is the equation to estimate Beta. But do we have to do it? Do we have to sit and calculate and run this regression? What if you are not exposed to this regression, then can you trade this? The good news is you need not calculate yourself. So if you go to any financial website of your country, you'll get Betas for most of the popular companies to companies which are traded well. So this is not a difficult thing to obtain. Once you obtain the Beta, all that you ought to do is you ought to sort companies based on Beta. So you can do it by industry, you can do it by market. And if you have to, by asset class. Suppose you are trading in different counties you can do it by country as well. So once you rank stocks based on Beta, then you're to calculate median beta and divide stocks into above median and below median. You know that's it, it's such a simple strategy. You do above median and below median. And you can pause for a while and think, what issued long and what issued short? So we said stocks which are in terms of Beta, they're all value. And stocks which are below median in terms of Beta, they are under value. So naturally the strategy is go long on those low Beta stocks and go short on high Beta stocks, and hold it for a particular period and then close the position. That's the strategy, strategy's very, very simple. So we did all these backgrounds so that you're able to read the paper and then, as I've said before, you're able to improvise. Because when these kinds of papers come a lot of other researchers work on these topics and they up the strategies further. So you should be able to understand that as well and that is why we spend a lot of time- explaining the background of this strategy. Otherwise the strategy is simple and straightforward. Another important question is about implementation. If you go back to Petrosky, I said that you have to wait for some time before, after the end of the year, after the end of any period. If you recollect, what is the reason? Because you'll have to wait for the accounting numbers to come. If your year ends on December 31st, htere is no way on January 1st you will know what the profits are, what the sales numbers are, you will not know that. So you have I know the auditor said that their contents have to prepare the numbers they have to get audited. The board has to audit, committee has to clear and there are a lot of procedures. However here that's not the case. All that you need to calculate Beta is return on market and return on stock price. Return on the stock, that's all you need. So, the expected return of a stock is calculated this way. So that is why this is quite easy to calculate return here. Suppose you trade, your trading period starts on say January, June 1st let's say. So what you ought to do is you ought to decide whether you will calculate Beta over six months, one years, two years, whatever works best in your setting. So once you select that period of two years, say June 2017 is when you want to trade. So then what you do is six months before that, so let's say July 1st so that January to June become six months. We've got this January to June six month period and calculate the average Beta. Now calculation is difficult you can just find out the average Beta for six months in the last from January to June. And that is the number for each company. And that you can calculate right as on June 30 after market does. You don't need to wait for some company research, because these are stock prices. So this trading strategy can be executed right on the first day of the year, month, whatever, based on your holding. How long you are to hold? Ideally you should hold for a month, but you can try various combinations. So what we have tried and we have tested using data is six month rolling window. Again, what is this rolling window business? So for every strategy, the way it works is, suppose for a month you create a high Beta, low Beta portfolio, it's quite possible that some high Beta stuff becomes low Beta next month. How? Let me give an example, assume that on July 1st, July 1st you start your trading. Now what is the estimation window for July 1st? That starts from January, ends on June. So this is the estimation window for July 1st and this is the trading, July 1st to August 1st, let's say. So this is the trading, so this is estimation and this is trading. Now, what do you do? January to June 30th, you calculate the Betas for all stocks, rank them, arrive at your longs, arrive at your shorts, and do this, hold this for one month. That is the first step. Now once this, on July 31st, this should be July 31st. [SOUND] Let's make it 31st of July. Now once this is done, the next month, what you should do is take this month out. Make it February to July. Why? This is called a rolling window. So make February to July and now calculate Beta all over again. So it's quite possible that your answer will change. Many of the companies which are upper median in terms of Beta may fall below median. Quiet possible. Of course those at the very top may not change, but those who are just about median it's quiet possible they slip into the other category. In those case you may have to change from long to short or short to long based on a stock has moved from above to below or below to above. It's quite possible, right? So here then, your trading will start on August 1st and end on August 31st, right? Again, so on and so forth right. Next one you would start in March, and your holding period will end on August. And the billing will be from September 1st to September 30th. All that you are to do is for any month, go back six months, beginning of the month, calculate pictures for all stocks, rank them, and then divide them into above median and below median. Go long on below median, short the more median, and hold for one month. That's all about this strategy. Now, again, are there risks here? Yes, of course. Like in any strategy, this is also risky. It is not a guaranteed money-making scheme. So that is why it's very important that you keep monitoring your portfolio. The problem, the major reason, although, theoretically, this idea is very sound. That constrained investors bid up the price of high Beta stocks. And that is where they were all valued. The determination of high Beta, the concept of Beta, itself, is based on past prices. That's a big problem. It's not necessary that the stocks which are high Beta here, so the Beta that we actually need is the Beta applicable to this period. But what we're using is the Beta that has happened in this period. So that is why there are times when information sets change, some high Beta stocks may become low Beta, or there is risk. It is not a strategy where there is no risk. But the research shows, 's paper shows that they've seen it in 20 countries. They've seen it in different asset classes. They've seen it in developed countries, they've tested this and it seems to work. And we have also done some of our own homework and our results indicates that this strategy works reasonably well. So try this strategy. Create a mock portfolio and using a mock portfolio see how this works and then you can carry on.
