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I am one of the approximately 500 people who sent in testimony or spoke in support of divesting from fossil fuels at recent meetings with the University of Hawaii Board of Regents. Divestment is a growing movement, and some have raised questions about its negative impact on investment risk and returns.

Some of this questioning springs from valid concerns, but a great deal of it has been clouded by biased analysis and prejudice against screening rather than rigorous investment mathematics.

At Aperio Group we attempt to cut through the intentional obfuscation by quantifying the impact of social or environmental screening on portfolio risk and return, an area where we can bring particular expertise and experience.

We recently published a study entitled “Do the Investment Math: Building a Carbon-Free Portfolio.”

The purpose of our study was to quantify the risk and return impact of eliminating fossil fuel companies from a public equity portfolio using both forecasted and back-tested analysis. The author of the study, Patrick Geddes, was the CFO and director of quantitative research for Morningstar.

The results of our study can be summarized by two slides:

Slide 1

• The first slide shows that the if you eliminate fossil-fuel companies from your portfolio and rebalance the remaining companies to track the market, the portfolio’s absolute risk will increase by only 0.01 percent, or 1/100^th of 1 percent.
• The theoretical return penalty for that amount of risk is 0.0034 percent, or less than one half of a basis point.
• So screening will impact portfolio risk and return, but by such a small amount we can fairly describe it as immaterial.

 Slide 2

• The second slide summarizes an historical back-test of a carbon-free portfolio for the 25-year period 1988-2012. For the back-test, we eliminated all Oil, Gas, and Consumable Fuel companies from our investment universe.
• For 73 percent of the rolling ten-year periods in our study, a carbon-free portfolio performed better than an unscreened portfolio.

In summary, by our estimates, divesting fossil fuels will have an immaterial impact on a public equity portfolio’s risk, and historically, and for the period tested, a carbon-free portfolio would have actually outperformed a portfolio that included fossil-fuel companies.

How will a carbon-free portfolio perform in the future? Our best guess is that it will perform roughly in line with the market, sometimes higher, sometimes lower, but with no material impact on portfolio risk.

We hope that our findings will help decision-makers understand and weigh the actual risks, costs and benefits of divestment.