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 is 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 portfolio’s long book is comprised of names that, leveraging OWL’s criteria for Diversity & Rights, score well (have positive exposure relative to broad market), and the short book contains companies that score the worst (have negative exposure relative to broad market). One portfolio does not constrain Sectors, whereas one 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 its 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.
Regardless of portfolio construction approach, larger and less volatile companies generally seem to have better Diversity & Rights characteristics.
Diversity & Rights as an Indicator for High ESG
The other remarkable aspect about companies with higher Diversity & Rights companies 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 varied perspectives help build better corporate policy, which can increase transparency and give markets more faith in leadership.
Below we look at the “Environmental Aggregate’ score, which takes all Environmental KPIs into consideration.
We see that Diversity & Rights portfolios have always consistently been more environmentally friendly than the broad market, but in recent times the broad market is catching up. Perhaps companies with more Diversity & Rights were more attuned to the trend in becoming more climate aware and attempting to mitigate their impact.
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
Factor Update: Axioma US Equity Risk Model (AXUS4-MH)
Factor Update: Axioma Worldwide Equity Risk Model (AXWW4-MH)
Please let us know if you’d like to learn more about incorporating ESG data into your own process, or would like to analyze your portfolio through the Omega Point factor lens.