SPHB - SPHB: Time To Sell The S&P 500 High Beta Components

2023-06-21 21:25:19 ET

Summary

• The Invesco S&P 500 High Beta ETF focuses on the highest beta stocks in the S&P 500 Index and has outperformed the S&P 500 this year.
• High beta stocks tend to outperform in bull markets and market rallies but exhibit larger drawdowns during risk-off events.
• The rally in the S&P 500 this year has been driven by only a handful of names, suggesting a potential risk-off event later this year, making it a good time for retail investors to sell SPHB and crystalize gains.

Thesis

The Invesco S&P 500 High Beta ETF ( SPHB ) is an equity exchange traded fund. The fund focuses on the highest beta stocks in the S&P 500 Index:

The Invesco S&P 500® High Beta ETF is based on the S&P 500® High Beta Index. The Fund will invest at least 90% of its total assets in the securities that comprise the Index. The Index is compiled, maintained and calculated by Standard & Poor's and consists of the 100 stocks from the S&P 500® Index with the highest sensitivity to market movements, or beta, over the past 12 months. Beta is a measure of relative risk and is the rate of change of a security's price. The Fund and the Index are rebalanced and reconstituted quarterly in February, May, August and November.

As per its literature, SPHB aims to follow the S&P 500 High Beta Index by investing at least 90% of its assets in the underlying index securities. The high beta index chooses the highest 100 beta stocks from the S&P 500 universe, and weighs them proportional to their beta coefficient. The result is a composition that is almost equal weighted, with each name's proportion of the holdings ranging from 0.8% to 1.9%. The index gets rebalanced quarterly, every February, May, August and November.

Given the propensity of tech stocks to exhibit a high beta coefficient, the fund and the index are unsurprisingly overweight information technology, which accounts for roughly 40% of the holdings.

High beta stocks tend to outperform in bull markets or market rallies, and we can clearly see that set-up this year:

SPHB is up over 20% this year, but more importantly it has consistently outperformed the S&P 500. We can see the orange line in the above graph, which depicts SPHB, being consistently above the violet line.

What is Beta

Beta is a fundamental concept in portfolio management and specifically market risk management. Beta measures a stock's move relative to the overall market. A beta greater than 1.0 indicates that a stock is generally more volatile than the overall market, while a beta lower than 1 references stocks that tend to move less than the market. For example, a stock with a beta of 2 will move twice the value of the overall market. So if the S&P 500 experiences a 10% correction, a stock with a beta of 2 will have a 20% correction.

Is the market now overpriced?

The S&P 500 has rallied furiously in 2023. Stocks go up on the back of either better earnings per share, or higher Price/Earnings ratios. The concept of earnings per share is easy to grasp, since it references increased net income / earnings for a corporation, which translates into more value for existing shareholders. Conversely, higher P/E ratios are more speculative in nature, since they address market views on potential higher earnings down the road, due to the actions taken by the underlying corporates. Bottom line is that equity bull markets highly correlated with higher earnings per share are more durable.

This year, the vast majority of stock price gains has come from an increase in P/E ratios. That means the underlying companies in the S&P 500 index have not increased their earnings, but the market is assigning a higher probability of growth down the road.

More importantly, the S&P 500 gains have been driven by only a handful of stocks:

New bull markets are characterized by market breadth. There is none to be had this year. As per the above graph, we have a handful of equities making up most of the index gains, while the 'Rest of Market' box accounts for only 1.4% of the index gains.

What we are seeing in fact, is the concentration of investors in a handful of stocks, and the reversion of oversold conditions in many high beta stocks.

Historic Performance for High Beta strategies

Let us have a look at how SPHB has fared historically versus the S&P 500:

As intuitively expected, SPHB outperforms in range bound or bull markets, and underperforms during market sell-offs. We can see how SPHB had a massive drawdown during the 2020 Covid sell-off, with the fund erasing almost 7 years' worth of gains.

This type of performance is expected given its composition. During risk-off events, market participants run for safety and exit risky positions. High beta names are the first to be sold, and low beta stocks such as utilities and healthcare are bought due to their perceived safety.

As a retail investor you do not want to be caught in SPHB during a risk-off event, since the drawdown can be fast and furious.

Conclusion

SPHB is an equity exchange traded fund. The vehicle aims to follow the S&P 500 High Beta Index by investing at least 90% of its assets in the underlying index equity names. The High Beta Index chooses the highest 100 beta stocks from the S&P 500 universe and weighs them proportional to their beta coefficient. In finance, beta measures a stock's move relative to the overall market. The higher the beta, the higher the volatility exhibited by a particular stock. High beta names tend to outperform in bull markets and market rallies, and exhibit larger drawdowns during risk-off events. The rally in the S&P 500 this year has been driven by only a handful of names and has also seen the reversion of oversold conditions in high beta names. We are of the opinion this is not a new bull market but yet another bear market rally, with a risk-off event to come later this year. A retail investor would do well to crystallize the 20% gains in SPHB this year by Selling this name.

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