What Drives Socially Conscious Investing?

Continuing our “Summer of Sustainability,” we’ll be examining the KPIs that have driven returns for the Social portion of “Environmental, Social, & Governance” over the past 5 years. We’ll also provide an update on market and factor (US & Worldwide) trends over the past week. Of particular note, we’ve seen recent strength in Profitability and Earnings Yield, while Size has taken a dive in both models. The risk-on factors of Market Sensitivity/Volatility have also sold off in the past few days as risk has started to tick backup in the US and worldwide.

‍Social Performance Decomposition

‍‍Last week, we dug into the individual KPIs that were driving performance in the Environmental basket of the ESG portfolios we’ve constructed using metrics from OWL Analytics. Today, we’ll run the same analysis on the Social segment, to determine how the market has valued KPIs within that space since 2014. In general, the Social criteria reflect how companies manage their relationships with employees, suppliers, customers, and the communities in which they operate. OWL’s Social data contains 6 KPIs split between two categories - Social - Employees and Social - Citizens.

‍Methodology:‍

• Take OWL Analytics’ 6 Social KPIs (full hierarchy below) and create equal weighted portfolios that are long the top 200 and short the bottom 200 companies in the Russell 1000, when ranked by their scoring on those KPIs.
• Bucket and aggregate all 6 portfolios to create a higher level “Social” portfolio.
• Create a sector neutral version of each of these portfolios to remove sector bias, then measure performance from 2014-2019.

As we’d established earlier, we’re measuring performance for each basket in a sector neutral fashion. Here’s what the broader Social portfolio has done since the beginning of 2014:

Social - Aggregate

As we can see in this chart, Social saw a major downdraft throughout most of 2018, and has since enjoyed a steep rally over the past several months. Here’s how each individual KPI portfolio has performed during this time:

‍Social - Compensation & Satisfaction

• After trading around a range up until late 2018, this metric has seen return skyrocket since Fall 2018, with the exception of a sharp drawdown in the first month of 2019.
• Of the 7.42% total return, factors contributed 6.14% vs. alpha at 1.28%.

Social - Diversity & Rights

• This KPI saw fairly consistent positive movement until taking a dive between Fall 2017 and Fall 2018. It too has rallied since the end of Jan 2019.
• Factor contribution was actually +3.96%, while negative alpha (-0.41%) created a headwind resulting in 3.55% total return.

Social - Education & Work Conditions

• This basket had consistently lost money since 2014, bottoming out at -7.5% on 6/21/18. Since then, it’s seen mostly positive movement as it digs itself out of that hole, and has started to really pop since mid-April 2019.
• Of the -2.96% total return for this period, +4.18% return has been from factors, while a disappointing -7.14% return came from alpha.

Social - Community & Charity

• After hitting a trough of -4% on 8/17/15, this KPI has mostly seen positive gains, save for a couple of tumbles in 1H2018 and the first two months of 2019. Yet again, we’ve seen a steep rally since mid-April.
• Of that 5.8% total return, 7.02% comes from factors, while alpha was negative at -1.2%.

Social - Human Rights

• This metric has seen the most consistent positive movement in the group, with a couple of slight downdrafts but nothing as pronounced as what we’ve seen in some of the others.
• Of the 10.2% total return, +1.48% was from factors, while an impressive +8.71% came from alpha.

Social - Sustainability Integration

• Our last portfolio traded around a range until early 2017, when it staged a big rally. It then saw prolonged weakness, including falling off a cliff in late-Feb 2018. Since then, movement has been largely positive.
• Of the 4.8% total return, 3.34% came from factors, and 1.46% from alpha.

Conclusions

‍Of the 6 KPIs under the Social umbrella, only one has had negative return since 2014. Additionally, each of these Social KPI portfolios and the broader Social portfolio have seen overwhelmingly positive performance in the past year. Human Rights is the KPI that we consider to be the most investable at the moment, given its consistent strength dating back to early 2016, as well as its significant performance contribution from alpha. All told, the data suggests that we’re in a bull cycle for companies that have graded well across these societal impact metrics, which is certainly a trend worth celebrating.

‍This week's market and factor update:

US Market (7/26/19 - 8/1/19)

• The S&P 500 had its worst week of 2019, down 3.1% this week (not fully captured in above chart) - its biggest drop since the selloff in December 2018 (but still up 17% on the year).
• The Fed cut rates on Wednesday by a widely expected 25bps, while less-dovish-than-desired comments from Powell prompted a selloff.
• The trade war reignited at full force after Trump announced an additional 10% tariff starting 9/1 on $300B worth of Chinese goods, extending the sell-off on Friday as China appears poised to retaliate.
• 2Q earnings for S&P 500 companies are now also on pace to record a decline for two consecutive quarters, which hasn’t happened since 1Q 2016.
• The July jobs report showed an additional 164k jobs in the US and steady unemployment, to little fanfare from investors.

Here’s how factors have moved over the past week in both US and global models, using our normalized return indicator:

US Model

• Earnings Yield was again the biggest gainer on a normalized basis, now up one whole standard deviation over the past two weeks.
• Market Sensitivity and Volatility peaked in the past few days and appear to both be in the process of reverting back to the mean, suggesting that risk-off is back in vogue.
• Size factor sold off heavily immediately after cresting into Overbought territory at +1.02 SD above the mean on 7/23.
• US Total Risk (using the Russell 3000 as proxy) bottomed at 12.86% on 7/30 and has since been moving higher, finishing the week at 12.95%.

‍Worldwide Model

• Profitability is now an Overbought factor after moving up more than 0.5 SD in the last week.
• Just as we’d seen in the US, global Size peaked at +1.62 SD above the mean on 7/23 and has since started reverting.
• Again mirroring the US, Market Sensitivity and Volatility have started to revert over the past few days.
• Global Total Risk (using the ACWI as proxy) ticked down to 11.35% on 7/30 and has since ticked up to finish flat week-over-week.

Regards,
Omer