When advisors analyze investments, they often rely on two main numbers: beta and correlation. Beta measures how much an investment might go up or down compared to the overall market, and correlation shows how closely two investments move in relation to each other. But typically, these numbers are just looked at as single, “top-line” values. iQUANT believes this approach is incomplete, much like judging an investment only by its average annual return instead of its compounded annual growth rate (CAGR) (prior post).
In reality, looking at beta and correlation separately in rising (“up”) and falling (“down”) markets can give a much better idea of how an investment will perform in different scenarios. iQUANT, one of the few firms taking this approach, offers valuable insights that help investors make more informed decisions.
How Misinterpreting Beta Can Lead to Missed Opportunities
Imagine an advisor is reviewing a growth-oriented investment with a top-line beta of 1.2. This beta indicates the investment is generally more volatile than the market, suggesting it would likely experience bigger swings both up and down. On the surface, an advisor might decide this investment is too risky for a client looking for growth but with some protection against market drops.
However, if the advisor looked closer at the investment’s “upside beta” (its beta during up markets) and “downside beta” (its beta during down markets), they might find a different story. Let’s say the investment’s upside beta is actually 1.5, meaning it gains 50% more than the market in rising conditions, but its downside beta is only 0.8. This would mean that while the invesment is likely to grow strongly in good markets, it’s less sensitive to losses when the market falls, making it more resilient than the top-line beta alone suggests.
By relying on the top-line beta, the advisor might dismiss the investment, missing an opportunity to add a high-growth component that also has a level of protection in downturns. In cases like these, looking at separate up and down market betas can help advisors find options that provide both upside potential and a degree of downside safety, aligning better with balanced growth strategies.
The same idea applies to correlation. If two investments have a correlation of 0.7, we know they tend to move somewhat in sync. But what if they only move together during bull markets and behave differently during bear markets? Knowing this could be critical in planning for market downturns.
Why the Industry Often Misses This
The investment industry tends to look at these top-line figures out of habit and simplicity. For years, advisors were taught to focus on basic stats, even if they don’t give the full picture. It’s similar to how average annual return was once used widely before people realized CAGR gave a clearer idea of long-term performance. By sticking with top-line beta and correlation, advisors may miss important details about an investment’s potential risks and benefits.
How iQuant Stands Out
iQUANT is one of the few research firms that offers beta and correlation numbers broken down by up and down markets. This approach allows advisors to see the full range of an investment’s behavior, from rallying markets to recessions. With these insights, iQUANT provides more accurate data to help advisors match their clients’ needs more precisely, building stronger, more balanced portfolios.
The Bottom Line
When managing portfolios, it’s CRITICAL for advisors to understand how investments react across different market conditions. By going beyond top-line beta and correlation numbers, they can get a more accurate sense of risk and return potential. iQUANT’s approach is helping advisors make better-informed decisions, aligning with clients’ goals for both growth and stability.
ADVISORS MUST THINK OUTSIDE THE BOX.