Reaching for Beta

Abstract

We show that equity mutual fund managers actively tilt their portfolios towards high-beta stocks when monetary policy is contractionary and short rates rise. This “reaching for beta” is persistent and manifests in sector-wide net buying of high-beta stocks. We rationalize this behavior in an equilibrium model. After a tightening, households who chase realized fund performance reallocate towards safe bank deposits. As market risk moves to more risk-averse banks, the equity premium rises, and fund managers paid on assets under management respond by increasing their portfolios’ market beta. Consistent with the model, reaching for beta is stronger for funds with more flow-sensitive investors, attracts fund inflows under tighter policy, and raises funds’ raw but not risk-adjusted returns. Unlike reaching for yield in bonds, tighter policy increases risk-taking in equities, revealing a beta channel of monetary policy transmission. Joint paper with Egemen Genc and Altan Pazarbasi.