Net beta

In early 2005, the Japanese equities market had an epic year. It felt like this time, it was different. The party came to a screeching halt when the Japanese authorities decided to arrest Takafumi Horie, CEO of Livedoor (JT:4753) and symbol of the new Japan. High-flying small caps rediscovered Newtonian physics.

We long high-flying small caps with esoteric business models, and short a few asthmatic "structural shorts" along with index futures. The fund manager quickly responded to the crisis by selling futures. Despite a reasonable +30% net exposure, the ship was taking on water fast. As a self-appointed risk manager, I promptly brought to his attention that we were synthetically exposed on the beta, market cap, exchange, and liquidity sides. With small caps at 1.7 and beyond on the long side, agonizing shorts at 0.8, and futures at 1 on the short side, our net beta was hovering around 0.7. As one investor later pointed out, we had a "beta of 1.5 on the...