Investing in Employee Diversity & Rights
Last week we had focused on analyzing the ‘Human Rights’ factor and found that companies scoring high on this measure had performed well historically but also offered investors positive exposure to similarly important ESG factors, most notably 'Diversity & Rights'.
This week we shift our attention to this 'Diversity & Rights' factor using the potent ESG datasets from our partners at OWL Analytics. As we discussed previously, investors have tremendous power in helping sustainably enact social change by choosing where they deploy their capital. 'Diversity & Rights' if implemented properly can carry tremendous societal benefits, and are found in the ‘Social - Employees’ family of ESG KPIs, as illustrated below.
Our goal today is to assess how the ‘Diversity & Rights' factor has performed historically (2015-2019) to better understand if this factor can also be viewed by investors as an important driver of returns.
Using the Russell 1000 as our universe, we created two long/short portfolios. Both portfolios' long books are comprised of names that score well using OWL’s criteria for Diversity & Rights (have positive exposure relative to broad market), and the short books contain companies that score poorly on diversity & Rights (have negative exposure relative to broad market). The first portfolio does not constrain sectors, while the second portfolio tries to be as sector neutral as possible. We differentiate the Sector Neutral portfolio using a ‘SN’ suffix in the charts below.
The portfolio was rebalanced monthly to ensure that it was incorporating the most recent OWL data and equally weighted to ensure we weren’t overly emphasizing any particular stock or a group of stocks (e.g. FANG).
Diversity & Rights: Cumulative Performance (1/1/15 - 6/20/19)
We see that both Diversity & Rights portfolios have positive performance over the long term. Below we break down these high-level results into more detail to better understand what is driving returns.
We see the non-sector neutral portfolio has positive performance, but it is all driven by factors. We expand the Style and Sector risk decomps below for more details:
The biggest driver of the non-Sector neutral portfolio’s return was that it's underweight to the Energy sector, which dramatically drops in the Sector neutral case. Both portfolios have favorable factor returns - negative exposure to Volatility, positive exposure to Medium-Term Momentum, and positive Exposure to Size all helped drive positive return.
Regardless of the portfolio construction approach used, larger and less volatile companies generally appear to exhibit superior Diversity & Rights characteristics.
Diversity & Rights as an Indicator for High ESG
The other noteworthy aspect about companies with higher Diversity & Rights is how much higher they score in the other broad ESG categories - Environmental and Governance.
Below is OWL Analytic’s 'Governance Aggregate’ score, which takes all Governance KPIs into consideration. We add the Russell 1000 as a representation of the broad market for comparison purposes.
We see that over this time period, companies with high Diversity & Rights scores have also been increasing their Governance scores at a much faster rate than the broad market. Perhaps companies with more heterogeneous staff and managerial inputs develop more varied perspectives that help build better corporate policy, which can increase transparency and give markets more faith in their overall leadership.
Below we look at the “Environmental Aggregate’ score, which takes all Environmental KPIs into consideration.
We see that Diversity & Rights portfolios have consistently been more environmentally friendly than the broad market, but it's important to note that in recent times the broad market is catching up on this front. Perhaps companies with more Diversity & Rights had historically been more attuned to being more climate sensitive for the well being of their employees and the communities they served, a trend that has definitely been adopted by more and more companies over the last several years.
Below we see the overall ESG score for these portfolios.
Again we see that high Diversity & Rights have much higher ESG scores than the rest of the broad market. While we see that this KPI hasn’t necessarily driven excess returns over the recent history, as more funds flow to this investment space, will we see more Alpha? Will we see enough systematic movement in these types of factors to warrant permanent addition to every factor risk model in the future?
Only time will tell, but to-date the evidence is showing that investing in a more diverse workforce and empowering them with clear rights benefits not just employees, but also positively impacts the firm's bottom-line, shareholder returns, and the well being of the communities they serve, among many other social, environmental, and governance benefits to society at-large.
US & Global Market Summary
US Market: 6/15/20 - 6/19/20
- The market ended a positive week on a down note as stocks tried to push back from Friday lows, with weakness driven by investor fears of resurgent COVID rates (Arizona and Florida both reported spikes in new cases) and disappointing jobs numbers.
- First-time claims for unemployment exceeded 1.5 million last week, outpacing consensus estimates of 1.3 million. This was the 13th consecutive week that new unemployment filings surpassed the 1 million mark.
- On Friday, the market digested news that China planned to accelerate purchases of US farm goods to comply with phase one of the trade deal.
- This week, the Fed announced that it would be buying individual corporate bonds, providing more support in the secondary market in addition to the ETF purchasing schedule that has already been installed.
Factor Update: Axioma US Equity Risk Model (AXUS4-MH)
- Size was again the biggest gainer as it continued to climb back from a low of -3.17 SD below the mean on 6/3, now sitting in Oversold space as it continues to revert.
- Momentum continued to tick back up towards the mean after touching a bottom of -1.8 SD below the mean on June 10.
- Profitability also moved up and back towards the mean from a recent trough of -2.45 SD below the mean on 5/26.
- Value appears to have hit a peak of +2.77 SD above the mean on 6/15, and has started to revert on a normalized basis.
- Volatility continued its decline, shedding the Extremely Overbought label as it sits at 1.99 SD above the mean.
- Market Sensitivity fell by 0.45 standard deviations and out of Overbought territory, now sitting at +0.9 SD above the mean.
- Earnings Yield was the biggest loser this week after peaking at +1.81 SD above the mean on 6/5. It’s not longer an Overbought factor as it sits at +0.88 SD above the mean.
- US Total Risk (using the Russell 3000 as proxy) declined by 36bps this week.
Factor Update: Axioma Worldwide Equity Risk Model (AXWW4-MH)
- Momentum saw the biggest global gain this week, lifting itself away from a recent trough of -3.13 SD below the mean on 6/10.
- The rally in Size persisted, as it now eyes Neutral territory after seeing another +0.53 Sd move.
- Exchange Rate Sensitivity entered Extremely Overbought space at +2.11 SD above the mean. Recall this factor was at -4.9 SD below the mean on 3/31.
- Value hit a peak of +2.72 SD above the mean on 6/17 and started to tick down, still Extremely Overbought space at +2.6 SD above the mean.
- Market Sensitivity and Volatility both saw declines on a normalized basis, with Market Sensitivity exiting Overbought territory at +0.97 SD above the mean.
- Global Risk (using the ACWI as proxy) fell by 41bps.