SPHB: When The Risk-Reward Theory Falls Apart

SPHB strategy

Invesco S&P 500 High Beta ETF (NYSEARCA:SPHB) started investing operations on 05/05/2011 and tracks the S&P 500 High Beta Index. It has 99 holdings, an expense ratio of 0.25% and a 30-day SEC yield of 1.19%. Distributions are paid quarterly.

As described by Invesco in the prospectus, the fund selects…

approximately 100 constituents of the S&P 500 ® Index that have the highest sensitivity to changes in market returns, or “beta,” over the past 12 months (…) The Underlying Index weights each constituent security in proportion to its beta, with the highest beta securities receiving the greatest weights.

By definition, the beta of an individual stock is calculated as:

Beta = Variance(Rm)/Covariance(Rs,Rm)​

Where Rs is the return of the stock, and Rm is the return of the market benchmark (in this case, the S&P 500). For the calculation of variance and covariance, returns are measured over a time unit in a given period (for example, daily returns in 12 months). A Beta of 1 means a stock is just as volatile as the S&P 500 index. A Beta larger than 1 indicates greater volatility, and a Beta less than 1 indicates lower volatility. Beta is often considered a measure of risk. SPHB strategy is based on the risk-reward paradigm: investing in high-risk stocks should bring a high reward.

The index is rebalanced quarterly, and the portfolio turnover rate was 66% in the most recent fiscal year. This article will use as a benchmark the parent index S&P 500, represented by SPDR S&P 500 ETF Trust (SPY).

SPHB portfolio

The portfolio is overweight in technology (29.2% of asset value) in the same proportion as SPY (29.3%). Compared to the parent index, SPHB significantly overweights financials (22.5%) and consumer discretionary (17.8%). Other sectors weigh no more than 11%. SPHB underweights mostly healthcare, communication, consumer staples, utilities and ignores energy.

The top 10 issuers, listed in the next table with fundamental ratios, represent 14.1% of asset value. All positions are below 1.6%, so the portfolio is well-diversified and risks related to individual stocks are low.

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Fundamentals

SPHB is cheaper than the S&P 500 regarding valuation ratios, as reported in the next table. Growth rates are mixed: earnings growth and sales growth are slightly below the benchmark, while cash flow growth is much higher.

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Data source: Fidelity

However, these gaps may not be typical of the strategy. Depending on market cycle phases, some sectors may be more volatile than others and get more weight. All sectors are not equal regarding fundamental ratios. For example, financial companies, whose valuation metrics are structurally cheaper than in other sectors (and less reliable), currently have a heavy weight in the portfolio and skew aggregate ratios to the cheap side.

Performance

Since 05/12/2011, SPHB has underperformed SPY by about 1.5% in annualized return. It also displays much higher risk metrics, as reported in the next table (maximum drawdown and volatility). These numbers make the high-risk / high-reward strategy quite questionable.

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Over the last 12 months, SPHB beats SPY by a short margin, and it shows deeper drawdowns again:

SPHB vs growth and value

SPHB fundamental metrics and sector breakdown are a blend of value and growth characteristics. The next chart compares 10-year returns of SPHB and 4 value and growth ETFs:

• SPDR Portfolio S&P 500 Value ETF (SPYV)
• SPDR Portfolio S&P 500 Growth ETF (SPYG)
• Vanguard Value ETF (VTV)
• Vanguard Growth ETF (VUG)

SPHB is far behind the growth funds, and shortly ahead of SPYV. Nevertheless, this time interval was mostly a bull market fueled by growth stocks. It may not represent the potential of SPHB on a complete market cycle. Over the last 3 years, more equally distributed in bullish and bearish periods, SPHB is the worst performer… which is not really encouraging.

Takeaway

Invesco S&P 500 High Beta ETF holds about 100 stocks of the S&P 500 index with higher volatility. It is well-diversified across holdings, but heavy in technology and financials. SPHB has characteristics pointing to a blend of growth and value styles. Past performance is underwhelming: the fund has been lagging its parent index, S&P 500, while showing deeper drawdowns and higher volatility. SPHB strategy based on the high-risk / high-reward paradigm has failed to bring excess return in a bull market, and it is unlikely to succeed over a complete market cycle.

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.