Case: Beta Management

Week 6
The Objectives
1. To gain practice in calculating risk and return
measures on stocks and portfolios, including
estimation of beta for stocks by simple
regressions.
2. To understand concepts of total risk, portfolio
risk, diversifiable and undiversifiable risk, and
how these relate to the beta.
3. To gain an appreciation of the relation between
risk and return, and the CAPM.
4. To allow an introductory discussion of
investment strategies.


The Issues
1. The Strategy
2. The Choices
3. The Risks
4. The Return
The Strategy
How should we describe Ms. Wolfes portfolio
management strategy?
Where is she adding value?
Why do you think she is following her existing
strategy? Why is she changing?

The Choices
What is her goal in investing in the stocks shes
considering?
Why these stocks?

The Risks
1. The total risk: the standard deviation of each
stock/fund.
Vanguard =15.96%, REIT = 32%,
Brown=28.30%.
2. The portfolio risk: 99% Vanguard + 1% Stock.
REIT= 15.82% Brown= 15.98%.
3. The beta (the risk that is not diversifiable):
REIT=0.147(t statistic=0.34).
Brown=1.16 (t statistic=4.08).
What is the relevant risk?
What Is the Economic Significance?
Consider the dollar impact on existing portfolio when the
new asset is added.
Current investment = $19.8 M in index fund of volatility,
with volatility of 15.96%. In terms of dollars, the volatility
is 0.1596*19.8 = $3.16 M.
If additional $200 K is invested in Brown, the new dollar
volatility is 0.1598x20=$3.196M, and dollars at risk
increase by $36,000 (3,196,000-3,160,000).
If additional $200 K is invested in the California REIT, the
dollars at risk decrease by $400.
If additional $200 K is invested in index itself, the dollars
at risk increase by $31,920.
Approximate beta of California REIT =
400/31,920=0.125(From regression, beta = 0.147).
Approximate beta of Brown = 36,000/31,920=1.13 (From
regression, beta = 1.16).

The (Required) Returns
1. What expected return is sufficient to induce you
to invest in either stock?

Some Information of REITS
(NAREIT, http://www.nareit.com)
REIT: Real Estate Investment Trust.
A REIT invests in income-producing property, and may
also invest in loans on property.
There are about 300 REITs, with about 2/3 traded on an
exchange, and with assets over $300 B.
Cumulative returns from 1/1/99 to 3/3/2003:
REIT=40.67%, S&P500 = -32.09%.
Volatility over 1/1/99 to 3/3/2003.
REIT = 11.71%, S&P = 22.16%.
Correlation between returns over 1/1/99 to 3/3/200:
0.2843.
REIT Index beta from daily data = 0.15.
Nareit vs S&P 500, 1/1/99 to 3/3/03
0
0.2
0.4
0.6
0.8
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1.4
1.6
1.8
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V
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S&P 500
Nareit Index