Is there a defensive equity factor? Can one be built? Although it seems like an easy question, the answer is not straightforward. The authors of this piece argue for a careful assessment of factor strategies to deliver a defensive profile convincing enough to attract investors. A defensive return-to-risk posture may or may not be achieved by obvious candidates like quality, low volatility, or growth for example. So, which style factors are acceptable and appropriate for the investor seeking a defensive portfolio? A set of three characteristics are proposed as a barometer of which defensive factors might fit the bill. From a theoretical view, high earnings quality, low leverage, and low volatility are the strongest candidates. Surprisingly, characteristics like high asset turnover, low investment, and high profitability are second-place factors whose success is determined by the specific definition used.  Growth shows up as a risk factor, with no defensive qualities.

In Search of a Defensive Equity Factor

  • Ross French and Niklas Gärtner
  • Journal of Portfolio Management
  • A version of this paper can be found here
  • Want to read our summaries of academic finance papers? Check out our Academic Research Insight category.

What are the research questions?

  1. What is the framework for building a defensive factor strategy?
  2. Which factors are empirically consistent with the three defensive attributes?
  3. Are the results robust?

What are the Academic Insights?

  1. Instead of a single objective of volatility reduction, a 3-attribute framework was used to frame the issue, including low risk of capital loss, low business cycle risk, and low market risk.  In addition to the attraction of long-term preservation of capital, this framework also recognized the value of diversification of economic exposures, and drawdown reduction to systematic defensive investors. Many factors were tested against the three defensive attributes. A negative relationship is expected to be observed for factors exhibiting defensive characteristics.
  2. Among the factors examined
    • Best performing defensive factors:
      • Low volatility is the obvious choice for a defensive factor and portfolios tilted toward low earnings volatility or low return volatility. Defensive stocks should have lower market risk than non-defensive stocks. In this case, low market risk is defined as a relatively lower variance of returns, less negative skewness, and fewer extreme returns. Obviously, defensive stocks should have lower market risk than non-defensive stocks. Three low volatility measures were evaluated: price volatility (Vol) calculated as weekly returns over the previous five years; earnings volatility (StdEPS) calculated as volatility of earnings over the previous five years standardized by average earnings level over the same period; and profitability volatility (StdROA), calculated as volatility of return on assets (ROA) over the previous five years standardized by the average over the same period.
      • Among the many quality candidates, low leverage appears to be the most robust factor and its defensive power is unaffected by the definition used. Low leverage, financial strength, and financial solvency are keys to a quality and defensive equity exposure. Five measures were analyzed including total assets to book equity (AE), total debt to total assets (DA), total debt to book equity (DE), net debt to book equity (NDE), and cash flow from operations to debt (OCFD).
      • High profitability is a defensive characteristic but its effectiveness depends on the definition used. The most effective definition uses “assets” in the denominator. The use of book value is hampered by the inability to eliminate high leverage in the factor. Higher profitability is negatively correlated with the probability of default. It is also likely mediated by leverage since higher ROA firms will need less leverage. Seven measures were analyzed including ROE, ROA, gross profitability over assets (GPA), cash earnings over assets (COP), cash flow from operations over assets (OCFA), net profit margin (NMAR), and return on invested capital (ROIC).
    • Factors with lackluster performance, definitely second-rate:
      • High asset turnover and high earnings quality defined by the level of accruals are definitely in line with theoretical explanations of defensive.  However, the empirical tests reveal only a “middling” impact on measuring a defensive factor. Setting aside the price anomaly issues associated with accruals, it stands to reason that lower accruals are related to lower risk. Since receivables carry credit risk and are correlated with the business cycle as well as being linked to accounting fraud. Three measures of accruals are analyzed including Acc1  (Richardson et al. 2005), Acc2 (Ball et al. 2016), and net operating assets over assets (NOA) (Hirshleifer et al. 2004).
      • A similar result is obtained using low investment. Low investment is good in theory but poor in execution. Low investment is often justified by arguments that shareholders are better off if managers return capital when there are no positive investment opportunities available. Others argue that R&D investments increase returns and reduce the probability of default. The definition matters quite a bit for using low investment as a defensive factor. Six measures are analyzed including abnormal capital investment (AbnCapex); growth rate of capital expenditures (CapexG); total asset (DAsset) and book equity (DEquity) growth; external financing growth (ExtFin) and share issuance growth (SIssueG).
      • High forecast growth appears to be a risk factor rather than a defensive one. Note the positive sign on the growth variable in Exhibit 4 below. Higher expectations of growth is associated with higher expected returns and higher risk.  Although others argue that growth is a quality factor valuable to investors, the growth measure is one where the definition should be considered carefully. Recognizing that growth is likely a risk factor and unlikely to exhibit defensive characteristics, a forward-looking measure is analyzed in this study: the median two-year forward earnings per share (EPS) forecast (Institutional Brokers’ Estimate System).
  3. YES. The robustness of the study is due to a number of features. First, there is a strong theoretical basis of the 3-attribute framework in relation to the best performing factors. Having a theoretical connection is important as it provides a sound fundamental basis for the empirical results and helps mitigate datamining biases. Second, additional confidence in the empirical results can be found in the database and design used.  Tests are first conducted on developed markets and then extrapolated to emerging markets.  Third, point-in-time data from Worldscope ensures survivorship or lookahead bias do not impair the generalizations drawn.  Finally, the universes were observed from September 2000 until December 31, 2021, for the top 90% of market capitalization firms insuring liquidity and investibility.

Why do defensive factors matter?

The search for a defensive equity factor has landed on a clear-cut answer to building a quantitative defensive equity investment strategy. Portfolios that are tilted towards measures of low volatility, high profitability, low leverage, high earning quality, and asset turnover will exhibit lower exposures to capital loss and permanent drawdowns.  I wonder how long will it take for the commercialization of a quantitative defensive strategy to occur.

 The most important chart from the paper

The results are hypothetical results and are NOT an indicator of future results and do NOT represent returns that any investor actually attained.  Indexes are unmanaged and do not reflect management or trading fees, and one cannot invest directly in an index.


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.

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About the Author: Tommi Johnsen, PhD

Tommi Johnsen, PhD
Tommi Johnsen is the former Director of the Reiman School of Finance and an Emeritus Professor at the Daniels College of Business at the University of Denver. She has worked extensively as a research consultant and investment advisor for institutional investors and wealth managers in quantitative methods and portfolio construction. She taught at the graduate and undergraduate levels and published research in several areas including: capital markets, portfolio management and performance analysis, financial applications of econometrics and the analysis of equity securities. In 2019, Dr. Johnsen published “Smarter Investing” with Palgrave/Macmillan, a top 10 in business book sales for the publisher.  She received her Ph.D. from the University of Colorado at Boulder, with a major field of study in Investments and a minor in Econometrics.  Currently, Dr. Johnsen is a consultant to wealthy families/individuals, asset managers, and wealth managers.

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