In Search of a Defensive Equity Factor

Abstract

The authors seek to establish which factors are appropriate for defensive investors, where defensiveness is defined along three dimensions: low risk of permanent capital loss, low business cycle risk, and low market risk. They analyze a range of volatility and quality factor characteristics through both a theoretical and empirical lens, discovering that low leverage, earnings volatility, and return volatility are the most consistently defensive. Profitability is the next most powerful characteristic, though for it to be reliably defensive, leverage must be controlled for in its definition or implementation. Asset turnover and earnings quality, measured by the level of accruals, have also empirically behaved like defensive characteristics, though to a lesser extent and less consistently. Low investment had lackluster results in all tests, whereas high forecast growth is confirmed to be entirely inappropriate for defensive investors.