For First Ship Lease Trust’s (SGX:D8DU) shareholders, and also potential investors in the stock, understanding how the stock’s risk and return characteristics can impact your portfolio is important. D8DU is exposed to market-wide risk, which arises from investing in the stock market. This risk reflects changes in economic and political factors that affects all stocks, and is measured by its beta. Not all stocks are expose to the same level of market risk, and the broad market index represents a beta value of one. A stock with a beta greater than one is expected to exhibit higher volatility resulting from market-wide shocks compared to one with a beta below one.

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An interpretation of D8DU’s beta

First Ship Lease Trust’s beta of 0.66 indicates that the stock value will be less variable compared to the whole stock market. The stock will exhibit muted movements in both the downside and upside, in response to changing economic conditions, whereas the general market may move by a lot more. Based on this beta value, D8DU appears to be a stock that an investor with a high-beta portfolio would look for to reduce risk exposure to the market.

How does D8DU’s size and industry impact its risk?

A market capitalisation of S$52.27M puts D8DU in the category of small-cap stocks, which tends to possess higher beta than larger companies. Moreover, D8DU’s industry, diversified financial, is considered to be cyclical, which means it is more volatile than the market over the economic cycle. Therefore, investors may expect high beta associated with small companies, as well as those operating in the diversified financial industry, relative to those more well-established firms in a more defensive industry. It seems as though there is an inconsistency in risks portrayed by D8DU’s size and industry relative to its actual beta value. There may be a more fundamental driver which can explain this inconsistency, which we will examine below.

Is D8DU’s cost structure indicative of a high beta?

During times of economic downturn, low demand may cause companies to readjust production of their goods and services. It is more difficult for companies to lower their cost, if the majority of these costs are generated by fixed assets. Therefore, this is a type of risk which is associated with higher beta. I test D8DU’s ratio of fixed assets to total assets in order to determine how high the risk is associated with this type of constraint. Considering fixed assets is virtually non-existent in D8DU’s operations, it has low dependency on fixed costs to generate revenue. Thus, we can expect D8DU to be more stable in the face of market movements, relative to its peers of similar size but with a higher portion of fixed assets on their books. Similarly, D8DU’s beta value conveys the same message.