Chasing Beta, Losing Alpha

In this paper, we tackle the Beta anomaly, namely the fact that high-Beta assets tend to be associated with lower risk-adjusted returns than low-Beta assets, and connect it to mutual funds' expectations. We present a model with two types of investors, mutual funds and hedge funds, with heterogeneous market expectations and margin constraints. We show that the Beta anomaly is especially present for stocks purchased by over-optimistic mutual funds. On the empirical side, we first introduce a mutual fund-level measure of market expectations. Then, portfolio analyses and regressions confirm the model's prediction. The results are robust to alternative definitions of the mutual funds’ market beliefs variable that correct for stock picking, and carry predictive power for mutual funds' returns