An Alternative Approach to Quality: Reconstructing the QMJ-Factor Using Augmented ESG-Data

Abstract

I construct a proprietary measure of stock quality, the Augmented ESG-score (AESG-score), that accounts not only for the Environmental, Social and Governance, but additionally the Economic sus-tainability of the underlying company. I show that the AESG-score is a persistent measure, stocks with high AESG-scores generally command higher prices and that an Alternative Quality Minus Junk -Factor (AQMJ-factor) that goes long stocks with high AESG-scores and short stocks with low AESG-scores yields statistically significant risk adjusted returns. I analyze the returns of 7 portfolios sorted on AESG-scores, and show that 4-factor alphas and portfolio Sharpe-ratios increase mono-tonically moving up in quality. The AQMJ-factor is robust to variety of specifications, and performs well in an Out-of-Sample analysis.