Through September 30, year-to-date returns for the lowest rated companies were -5.5%, vs. 8.4% for the highest rated companies, or a spread of 13.9%. The spread widened significantly during the summer months, in contrast to many quantitative models used by leading investment managers.
As in multi-year studies, this measure of corporate integrity has been a consistent indicator of investment returns. High risk companies underperform the market by a wide margin, while companies exhibiting high levels of integrity show returns much higher than market averages.
The average annual spread between the worst and best-rated companies from 1997-2006 was 21.5%.
“Two things are clear from our research,” said Jack Zwingli, CEO of Audit Integrity. “First, the ratings work overall, but they worked particularly well during difficult markets. The results during the volatile summer months were similar to what we saw during the turbulent years after the dot com crash. Two things are likely happening – an investor ‘flight to quality’ and an exposing of weak companies when times get tough.
“Second, these ratings are unique, as they have virtually no correlation to conventional fundamental or valuation analysis,” he added. “Even more noteworthy than the good performance of our best rated firms this summer was the deep valley of negative returns from our worst rated companies.
The share prices of these high-risk firms didn’t artificially rise in short squeezes during July and August, because few were being recognized as short-sell opportunities by conventional approaches.”
The year-to-date (YTD) analysis showed that the performance of the equity risk ratings grew stronger during the dramatic market volatility from June through September. The underperformance of low-rated companies accelerated, as cumulative YTD investor returns dropped from 4.5% in May to .5 % in June, -5.7% in July to -9% in August.
Both the year-to-date and 10-year returns analyses were conducted using the Equity Performance Risk ratings of Audit Integrity. These are derived from the firm’s flagship Accounting and Governance Risk (AGR^® ) scores, a comprehensive measure of corporate integrity. The tests were conducted using the FactSet Alpha Testing application. Audit Integrity recently began providing its ratings via the FactSet service.