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Zero-Beta Portfolio

Zero-Beta Portfolio

What is a Zero-Beta Portfolio

A zero-beta portfolio is a portfolio constructed to have zero systematic risk or, in other words, a beta of zero. A zero-beta portfolio would have the same expected return as the risk-free rate. Such a portfolio would have zero correlation with market movements, given that its expected return equals the risk-free rate or a relatively low rate of return compared to higher-beta portfolios.

 

BREAKING DOWN Zero-Beta Portfolio

As a simple example of a zero-beta portfolio, consider the following. A portfolio manager wants to construct a zero-beta portfolio versus the S&P 500 index. The manager has $5 million to invest and is considering the following investment choices:

 

Stock 1: has a beta of 0.95

Stock 2: has a beta of 0.55

Bond 1: has a beta of 0.2
Bond 2: has a beta of -0.5
Commodity 1: has a beta of -0.8

 

If the investment manager allocated capital in the following way, he would create a portfolio with a beta of approximately zero:

 

Stock 1: $700,000 (14% of the portfolio; a weighted-beta of 0.133)

Stock 2: $1,400,000 (28% of the portfolio; a weighted-beta of 0.182)
Bond 1: $400,000 (8% of the portfolio; a weighted-beta of 0.016)
Bond 2: $1million (20% of the portfolio; a weighted-beta of -0.1)
Commodity 1: $1.5 million (20% of the portfolio; a weighted-beta of -0.24)

This portfolio would have a beta of -0.009, which is considered a near-zero beta portfolio.

 

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