FFI Perspectives

Fossil Free Indexes US — Inside the Numbers: Part I

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.

Leave a Reply