How correlated is news sentiment with other quant factors?

In the previous blog-posting, I presented some of the key findings of a quant factor analysis based on news sentiment conducted by Macquarie Research. This blog-posting will be focusing on the same report (May edition of Factorial! Under the title “Breaking News: How to use news sentiment to pick stocks”), but presenting their findings looking into the correlations between news sentiment-based quant factors and the more traditional quant factors. As previously stated, this is obviously important since quants are not only interested in a positive Information Coefficient, but also how it correlates with other factors - otherwise there is little benefit from adding it to a multifactor model.

Focusing on the news sentiment factors themselves, Macquarie finds that different types of news scores are somewhat uncorrelated, at least to the extent that diversification effects are available. More important for quants is the correlation between news sentiment and other common quant factors. In general, the performance of news sentiment is relatively uncorrelated with value, but has higher correlations with price momentum, earnings revisions and earnings surprises.

In addition, Macquarie look at the correlations between the average correlation of their composite news sentiment factor with every factor in each factor bucket. Surprisingly, news sentiment performance has the highest average correlation with momentum and analyst sentiment factors, but this correlation is not as high as expected. In fact, it is below 40% against both momentum and analyst sentiment factors (Fig. 37).

Based on these findings, Macquarie concludes that this means news sentiment has the potential to add value as an additional factor in a multifactor model.