The Fossil Free Indexes US (FFIUS) (and its companion total return index, the FFIUST) was created to provide investors of all stripes a way to pursue a low-carbon approach to portfolio management. Toward this end, constructing a broad-market large-capitalization stock index makes a lot of sense. The S&P 500 is an obvious choice as the starting point for creating such an index for US stocks. Applying a negative screen to the S&P 500, based on The Carbon Underground 200, is a simple, intuitive method for achieving the FFI goal.
The FFIUS was not designed for the purpose of competing with or mimicking the S&P 500. Yet, inevitably the question arises how the performance of the two indexes compares. A few words on this question follow.
Return is usually the primary focus of investors when thinking about performance. Stated simply, the returns of the two indexes are not distinguishable, at least based on an examination of the daily returns data from January 2, 2004 through May 30, 2014. A two-sample t-test for differences in the daily mean returns was unable to reject the hypothesis of equal average daily returns at a significance level of 1%. The same test was applied to each of three sub-periods, covering the run-up to the financial crisis, the crisis and “green shoots” period, and the recovery period. In each of these sub-periods the statistical test was unable to reject the hypothesis of equal average daily returns.
Return is not the whole story of either performance or relative performance. Risk is the umbrella term for the rest of the performance story. The FFIUS and S&P 500 are also similar according to a variety of measures of risk. These will be discussed in a subsequent post.
Interpreting relative performance of the FFIUS and S&P 500 (or any other index) requires a closer look at the conceptual framework that determines how we interpret the evidence. For example, it has become a widespread belief that imposing any constraint (such as a negative screen) in index or portfolio construction must entail a sacrifice in expected return. This belief may be misplaced in certain contexts. The interpretive framework will be discussed in another post.