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Investors should be more discerning on alternative data, says AXA IM research

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Earnings quality should be considered through the lens of board diversity, while new alternative forms of data will demand greater discernment from investors, according to AXA Investment Managers (AXA IM).

Hosting a series of roundtables for Australian institutional clients and consultants across the country this week, Rosenberg Equities, AXA IM’s quantitative platform, shared new insights into how diversity and alternative data may impact long-term equity investing. 
 
New research from AXA IM Rosenberg Equities shows the level of board diversity is not only associated with higher contemporaneous returns but can also be a predictor of better financial outcomes and a company’s ability to protect future profits. 
 
The study of the 1,000 largest US companies between January 2005 and July 2017 confirmed the growing body of evidence that diversity within organisations has a direct positive bottom-line effect.
 
Specifically, the study found that more diverse companies do exhibit higher contemporaneous returns on equity, while companies that are more diverse are more likely to be more profitable one year on, and board diversity can provide a ‘profitability moat’ to companies that are already profitable and seeking to keep competition at bay.
 
“Earnings quality is a combination of both company profitability and stability of earnings. So, finding companies that can sustain profitability over time is critical to achieving risk-adjusted returns,” says Kathryn McDonald, Head of Sustainable Investing, AXA IM Rosenberg Equities.
 
Generally, the most profitable companies in any sector experience a decline in forward one-year profitability as these are the companies that usually face the most competitive pressures. Of the top 25 per cent of companies by profitability, AXA IM Rosenberg Equities found that, while these companies faced considerable downward pressure on profits over the period 2005-2017, those with higher diversity on average fared significantly better.  Board diversity appears to, therefore, provide a ‘profitability moat’ as more diverse groups of people are generally able to problem solve better than homogenous groups.
 
McDonald says: “Our study shows that board diversity is an important characteristic for investors to consider as it is a key predictive measure of a company’s ability to withstand competitive forces and therefore a ‘must-have’ in the face of intense market competition.”
 
The study assigned a diversity score to the companies based on gender diversity and/or evidence of non-US nationality of board members. Companies were classified as ‘higher diversity’ if the board diversity score was greater than 20 per cent.  Profitability was defined as return on equity net extraordinary items.
 
“AXA IM is firmly of the view that environmental, social and governance (ESG) factors such as diversity are material economic indicators and is using diversity data to improve its own earnings forecasts”, says McDonald. 
 
New and alternative data sets, such as media sentiment and crowd-sourced opinion data, are being touted as offering investors an ‘edge’ over traditional data such as analysts’ reports, company accounts and market research. However, while these new alternative data sets can potentially provide valuable insights, there are significant challenges to working successfully with this information.
 
“There is an argument that, as more information becomes available, markets should become more efficient, but that is not necessarily what we are seeing,” says Gideon Smith (pictured), Europe Chief Investment Officer, AXA IM Rosenberg Equities.
 
According to Smith, artificial intelligence is enabling the conversion of information into investment insight and, as a result, a whole new industry of financial market alternative data providers is emerging. The most frequently used alternative data sets are web content scraping, media sentiment, credit card point-of-sales and search trends. Yet there are inherent challenges to working with this new alternative data as it can be prone to ‘herding’ and ‘noise’.
 
“Data is often called ‘the new oil’ – but this metaphor is apt not just because data is a valuable resource, but because you have to refine it in order to extract its value” says Smith. “The secret to extracting and refining that value is to find structure within the data set, and visualisation is a key tool for this.”
 
AXA IM Rosenberg Equities is using alternative data such as news sentiment which offers a potential source of value when combined with traditional data sources such as price sentiment and analyst recommendations.
 
“The winners in this brave new world of alternative data will be the people who can handle the quantity of information and refine that information in order to extract its value,” says Smith.

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