Fossil Fuel Divestment: A Costly and Ineffective Investment Strategy
Prof. Daniel R. Fischel 1
President and Chairman,
Compass Lexecon
I.

Introduction
1.

In recent years, certain groups concerned with the potential effects of global

climate change have urged institutions and other investors to divest from securities associatedwith companies that explore for, produce, market and/or exploit fossil fuels. Advocacy for fossil
fuel divestment began in 2011 on college campuses like Swarthmore College in Pennsylvania
and Hampshire College in Massachusetts, and in 2012, Seattle became the first municipal entity
to commit to fossil fuel divestiture goals. 22.

Since then, varying degrees of divestment have been adopted by some otherinstitutions, while being rejected by others. For instance, in May 2014, Stanford University’s
Board of Trustees announced that it would undertake a limited divestment, focused exclusively
on coal mining companies, and in September 2014, the Rockefeller Brothers Fund announced
that it planned to substantially reduce its investments in fossil fuel companies. 3 Fossil Free, aproject of the environmental group 350.org and a leading advocate of divestment, claims that,during 2014, 181 institutions and local governments, along with 656 individuals, divested a total

1.
2.
3.

My qualifications are described in Appendix A. I have been assisted in preparing this report by membersof Compass Lexecon’s professional staff. This study has been commissioned and financed by the
Independent Petroleum Association of America (IPAA).
Michelle Y. Raji (2014) “Timeline: Fossil Fuels Divestment,” Harvard Crimson, October 2, 2014.
Michael Wines (2014) “Stanford to Purge $18 Billion Endowment of Coal Stock,” New York Times, May 7,
2014; Michael Calia (2014) “Rockefeller Fund Seeks to Shed Fossil-Fuel Investments; Family, Whose
Fortune is from Oil, Aims to Limit Bets on Coal, Tar Sands in its Fund,” Wall Street Journal, September
22, 2014.

1

of $50 billion worth of assets. 4 Divestments by government entities, educational institutions, andphilanthropic foundations constitute approximately 95 percent of these assets. 5
3.

By contrast, other institutions have resisted activists’ calls for divestment.

Trustees at American University voted in November 2014 to keep fossil fuel-related investments
held in their endowment fund, indicating that divestment would double its annual management
fees. 6 Harvard University, which holds the largest university endowment valued at more than
$32 billion, has also opposed divestment. Harvard’s President, Drew Faust, commented:“Divestment is likely to have negligible financial impact on the affectedcompanies. And such a strategy would diminish the influence or voice we might
have with this industry. Divestment pits concerned citizens and institutions
against companies that have enormous capacity and responsibility to promote
progress toward a more sustainable future.” 7
4.

Public commentary about divestment has also increased substantially. A recent

opinion piece in the New York Times advocated greater debate about divestment on college
campuses. It suggested that the costs of divestment to investors would be “not much,” and thepotential benefits large, pointing to a divestiture campaign in the 1980s focused on Apartheid-era
South African companies. 8
5.

Certainly, before divesting, investors and institutional fund managers should

consider the costs of divestiture and the likelihood that divestiture will contribute meaningfully
4.
5.
6.
7.
8.

Fossil Free (2014) “Fossil Fuel Divestment: 2014 Accomplishments and Next Steps,”
http://gofossilfree.org/usa/wp-content/uploads/sites/6/2014/12/Divestment-Accomplishments-October2014-Public.pdf.
Arabella Advisors (2014) “Measuring the Global Fossil Fuel Divestment Movement,” September 2014,
http://www.arabellaadvisors.com/research/measuring-the-global-fossil-fuel-divestment-movement/.
Jeffrey A. Sine, Chair, Board of Trustees (2014) “Memorandum to American University Community,”
November 21, 2014, http://www.american.edu/trustees/Announcement-November-21-2014.cfm.
Drew Faust, Harvard University Office of the President (2013) “Fossil Fuel Divestment Statement,”
October 3, 2013, http://www.harvard.edu/president/fossil-fuels.
Evan J. Mandery (2014) “The Missing Campus Climate Debate,” New York Times, November 2, 2014.

2

to desirable environmental goals. In this report, I address these issues from the perspective offinancial economics, relying on widely-accepted principles of the field, as well as the large
literature on prior divestiture campaigns, including the South African case. I conclude that thecosts to investors of fossil fuel divestiture are highly likely and substantial, while the potential
benefits – to the extent there are any – are ill-defined and uncertain at best. Fossil fueldivestiture is therefore unlikely to pass a cost-benefit test, particularly compared with alternative
ways investors who so desire can promote environmental goals.
II.

Divestiture involves substantial costs for investors and others.
6.

Investors seeking to comply with the goals of fossil fuel divestiture potentially

incur three key types of costs, described here and discussed more fully below:•

Trading costs. Divestiture involves selling certain securities and presumably buying
others, both of which involve payment of broker commissions and bid-ask spreads.

•

Diversification costs. By restricting the securities that can be included in a portfolio,
it is widely recognized that an investor loses the benefits of diversification, suffering
lower investment returns for a given level of portfolio risk.

•

Compliance costs. Investors must identify the specific securities to be divested froman existing portfolio. Moreover, because firms evolve over time and new investment
opportunities arise, there will be ongoing compliance costs to ensure that the portfolio
continues to meet the desired standards.

7.

These costs reduce the returns of an institution’s investments and thereby reducethe institution’s ability to achieve its goals. As one article on university endowment spending by
the Association of American Universities noted, “[b]y far the most common categories ofendowment expenditures are scholarships and financial aid, faculty chairs and salaries and3

academic support programs.” 9 The article also states that “[m]any institutions with significant
endowments are making college free for thousands of low- and moderate-income students.” 10
According to one study, higher education operating budgets receive 8.8 percent of their funding
annually from endowments. 11 A recent economic study of 24 years of university endowment
data found that negative endowment returns lead to substantially lower payouts to funduniversity operations: “a 10 percent negative endowment return is associated with an 8.2 percent
reduction in payouts.” 12 The same study further found that “[a] negative endowment shock
equivalent to 10 percent of a university’s budget leads to a 4.9 percent reduction in the number oftenure-system faculty during the following year … In addition to reducing tenure-system faculty,
universities react to negative shocks by also cutting support employees (e.g., secretaries) and tosome extent maintenance employees.” 13 The costs imposed by divestment therefore have real
impacts on institutions and those who rely upon them. I discuss each of these costs in detailbelow.
A. Trading Costs
8.

Divestment generates trading costs for investors, including processing andexecution costs. Trade processing costs include payments to investment professionals to manage
and facilitate trades, as well as exchange fees and taxes involved in trading securities. These
costs vary across traders, depending on the types of securities they hold and whether they have
9.
10.
11.
12.
13.

“Myths About College and University Endowments,” Association of American Universities, January 2009(https://www.aau.edu/WorkArea/DownloadAsset.aspx?id=7792).
Id.
NACUBO (2013) “Educational Endowments’ Investment Returns Averaged 11.7% in FY2013; Strong
Improvement Over FY2012’s -0.3%,” Press Release, January 28, 2014,
http://www.nacubo.org/Documents/EndowmentFiles/2013NCSEPressReleaseFinal.pdf.
Jeffrey R. Brown, Stephen G. Dimmock, Jun-Koo Kang, & Scott J. Weisbenner (2014) “How University
Endowments Respond to Financial Market Shocks: Evidence and Implications,” American Economic
Review 104(3):931-62, at 949.
Id., at 933-34.

4

investment professionals in-house, but they are often substantial, with a recent study finding that
institutional separate account fees for a large-cap domestic equity portfolio average 0.53 percent
of assets. 14
9.

Execution costs include the payment of an effective bid-ask spread and any priceimpacts from a trade. The bid-ask spread is the difference between the price to sell a security
and the price to buy the same security, with the latter typically being higher. 15 Financial
economists typically recognize the bid-ask spread as the fee security dealers earn for supplying
liquidity to traders. 16 An investor incurs costs relating to the bid-ask spread both on the sale ofsecurities targeted for divestment (which would be sold at the relatively low bid price) and on thepurchase of replacement securities (which would be bought at the relatively high ask price).
10.

The price impact component of execution is “the price concession an investor

may be forced to make for trading in in quantities greater than those associated with the posted
bid or ask price.” 17 In other words, to sell a large quantity of securities, an investor must offer alower price, and to buy a large quantity of securities, an investor must pay a higher price. An
academic study of large investment management firms indicates that the average price impact oftrading for institutional investors is -0.35 percent of the price for sells and 1.0 percent for buys. 18
11.

A recent estimate from a widely-used source indicates that average processing

and execution costs for an institutional equity investor are approximately $0.18 per $100 of

14.
15.
16.
17.
18.

Investment Company Institute (2006) “Mutual Funds and Institutional Accounts: A Comparison,” at p. 2.
Zvi Bodie, Alex Kane, and Alan J. Marcus (2014) Investments, Tenth Edition, McGraw-Hill Irwin, at p. 64.
John Y. Campbell, Andrew W. Lo, and A. Craig MacKinlay (1997) The Econometrics of Financial
Markets, Princeton University Press, at p. 100.
Zvi Bodie, Alex Kane, and Alan J. Marcus (2014) Investments, Tenth Edition, McGraw-Hill Irwin, at p. 76.
Louis K.C. Chan & Josef Lakonishok (1995) “The Behavior of Stock Prices Around Institutional Trades,”Journal of Finance, (4):1147-1174, at p. 1148.

5

trading activity. 19 The National Association of College and University Business Officers reportsthat university endowments hold approximately $23 billion in energy-related assets. 20 If all ofthese assets were divested, the benchmark described above would indicate a total cost forprocessing and execution alone of $40.2 million. If as described above, divestiture generated a
0.35 percent price impact for stock sales and a 1.0 percent impact for stock purchases, thisadditional price impact would add $308 million in trading costs.
B. Diversification Costs
12.

Investors typically want returns that are both high and steady from period toperiod. However, there is a tradeoff between investment risk and return, with higher returns
usually available only by taking on more risk. However, when an investor diversifies theirportfolio by spreading their investment across more assets, it is widely recognized that theinvestor can avoid this tradeoff and achieve a higher average return without an increase in risk. 21
For the same reasons, restricting certain assets from a portfolio, as is required by a divestment
policy, reduces the average expected return from the portfolio at a given level of risk.

19.

20.

21.

Elkins/McSherry Bundled VWAP Global Universe 4Q12 Estimates. This analysis is based on a survey ofmajor institutional traders, and is commonly used in the financial economics literature. It includes a priceimpact of 0.04 percent. See, e.g., Thomas, C.P., Warnock, F.E., & Wongswan, J. (2004) “The Performanceof International Equity Portfolios,” Board of Governors of the Federal Reserve System International
Finance Discussion Papers, Number 817; Domowitz, I., Glen, J., & Madhavan, A., (2001) “Liquidity,
Volatility, and Equity Trading Costs across Countries and Over Time,” International Finance, 4(2):221255.
According to 2013 NACUBO reports, the value of college endowments totaled more than$456,000,000,000 and endowments held approximately 5% of their assets in energy. Therefore, the valueof energy assets was approximately $22,800,000,000. See, NACUBO, (2014) “U.S. and Canadian
Institutions Listed by Fiscal Year 2013 Endowment Market Value and Change in Endowment Market
Value from FY 2012 to FY 2013,” Revised February 2014 and the 2013 NACUBO – Commonfund Studyof Endowments.
Burton G. Malkiel (2011) A Random Walk Down Wall Street: The Time-Tested Strategy for Successful
Investing, W.W. Norton & Co., at pp. 202-214. This result requires that the assets not be perfectly
positively correlated with each other, as I describe below.

6

13.

A standard way to evaluate the potential diversification benefits of any security or

set of securities is to calculate the correlation of that security with the rest of the portfolio. The
more uncorrelated a security is with the rest of the portfolio, the greater the diversification
benefit it generates (and, by the same principle, the greater the cost associated with divesting that
security). We analyzed the correlations between stocks in the energy sector – i.e., those stocks
most likely to be targets for divestment – and stocks in other sectors over the 50-year time frame
1965-2014. Claims that the performance costs of divestment are low typically focus on shortertime frames which can generate misleading results. 22
14.

Our data source on historical equity returns is the CRSP US Stock database,which is widely used in the academic community to study stock returns. In particular, thisdatabase contains all securities whose primary listings are on the NYSE, NYSE MKT (formerly
known as Amex), NASDAQ, and ARCA exchanges. We included in our analysis all suchsecurities that are assigned an SIC industry code by CRSP, using the most recent SIC code
assigned to the security.
15.

We identified each SIC code with one of 10 industry sectors, including the energy

sector, based on the classification used in Fama and French (1997), updated to the current stocklistings. 23 For each of the 10 sectors, we constructed a value-weighted index of all the stocks inour data and tracked those indices each day during the 50-year period 1965-2014.

22.

23.

For example, in the aforementioned New York Times editorial, the author claims that “[s]ome researchsuggests that endowments would have performed better over the past decade had they excluded fossil-fuelcompanies.” Evan J. Mandery (2014) “The Missing Campus Climate Debate,” New York Times, November
2, 2014.
Eugene F. Fama and Kenneth R. French (1997) “Industry Costs of Equity,” Journal of Financial
Economics, 43(2):153-93. An update of this classification is provided at
http://mba.tuck.dartmouth.edu/pages/faculty/ken.french/data_library.html.

7

16.

The standard measure of correlation is the correlation coefficient, which ranges

between -1.0 and +1.0. 24 A correlation coefficient of -1.0 indicates a security that is perfectly
negatively correlated with the portfolio, such that whenever the portfolio’s value increases, thesecurity in question declines proportionally in value (and vice-versa). A correlation coefficientof +1.0 indicates a security that is perfectly positively correlated with the portfolio, such thatwhenever the portfolio’s value increases, the security in question also increases proportionally invalue (and vice-versa). A correlation coefficient of 0.0 means there is no statistical relationshipbetween the portfolio’s return and the return of the security in question.
17.

For each of the ten sectors, we created a value-weighted stock price index for

stocks in that sector and another value-weighted index of all stocks in the other nine sectors, andcalculated the correlation between the returns of these two indices over the 1965-2014 period.
Exhibit A shows the correlations between each sector and the rest of the market. Of the ten
sectors, the energy sector has the lowest correlation with all other sectors, and therefore
the largest potential diversification benefits relative to the other nine sectors. Moreover, thesector with the second lowest correlation with other sectors is the utility sector, another sector
that includes many likely fossil fuel divestment targets. These results indicate the potential for
substantial diversification costs associated with fossil fuel divestment.
18.

To further quantify these costs, we also undertook an analysis of the reduction in

the average return an investor who divested from the energy sector would have received over the
1965-2014 period, relative to the average return received by an investor who did not divest.
Obviously, investors hold many different portfolios, and as discussed in the following section,
24.

Burton G. Malkiel (2011) A Random Walk Down Wall Street: The Time-Tested Strategy for Successful
Investing, W.W. Norton & Co., at p. 206.

8

there are numerous ways an investor could implement fossil fuel divestment. It would be
impossible to precisely quantify the value of diversification for every possible investor and every
possible divestment strategy. However, as a rough gauge of the overall magnitude ofdiversification costs, we estimated the reduction in returns to an investor who held the “market
portfolio” – i.e., the average equity investor in the market.
19.

We also considered what is likely among the simplest and lowest compliance-cost

strategies for divestment, namely excluding from the portfolio any stock of a company in theenergy sector, as defined above. It is possible (although far from certain) that a more fine-tuned
divestment strategy that distinguished between different companies within this sector, or which
also identified select companies from other sectors like the auto industry, could have lower
diversification losses, but, as discussed in the following section, compliance costs for such a
strategy would also be higher.
20.

Because returns on equities vary substantially over short periods of time, we

analyzed the effect of divestiture over a very long historical period – as noted above, the fifty
years from 1965 to 2014. It is possible that the future benefits of diversification will be larger orsmaller than past effects, and moreover, the impact of divestiture can vary substantiallydepending on whether an investor happens to make trades during a downswing or upswing in themarket or energy sector. Recent changes in global energy markets have exerted significant
downward pressure on fossil fuel prices. For example, the Brent Crude Oil Index declined bynearly 50 percent from June 2014 to December 2014. As would be expected, these declines inunderlying commodity prices have also been associated with declines in the share prices formany public companies engaged in the exploration and production of fossil fuels (the S&P 500
Energy Index declined by approximately 15% from June 2014 to December 2014). The fifty
9year historical time period we examine as part of this analysis also captures other declines incrude oil markets including two where the price declined by 60 percent or more in a calendar
year (1986 and 2008). Regardless of recent events, there is no way to reliably predict future
returns in advance, and therefore, the best guide to the potential effects of diversification – andthe standard approach of financial scholars and analysts to such questions – is to examine longterm averages.
21.

Appendix B describes our methodology, which is summarized briefly here. We

first constructed a value-weighted index of energy stock prices using the energy sector SIC
codes, as discussed above. Separately, we also constructed a single value-weighted index of all
non-energy stock prices across the other nine sectors. We then identified, based on the fifty year
history for all of these stocks, the optimal portfolio ratio for the energy and non-energy indicesthat maximizes the overall average return, relative to the standard deviation – a standard measureof portfolio risk.
22.

This optimal portfolio experienced an average annualized excess return over the

1965-2014 period of 6.5 percent, while the similarly-calculated return for the non-energy stockindex was only 5.8 percent. This indicates a gross reduction in return of 0.7 percent per year due
to divestment. However, this calculation is incomplete because it does not account fordifferences in risk between the two portfolios. Indeed, the optimal portfolio’s standard deviation
is higher, 16.2 percent, indicating greater volatility relative to the non-energy stock index’s
standard deviation of 15.7 percent.
23.

Therefore, an investor who chose to divest would experience a lower return, butwould also see the relative volatility of his portfolio decline. However, there is no reason why

10divestiture alone would change an investor’s attitude towards risk. As such, to appropriately
compare divested and non-divested portfolios, we risk-adjusted the optimal equity portfolio tomake it comparable to the divested non-energy stock index portfolio. Specifically, we allocateda share of the funds in the optimal portfolio including energy stocks to an essentially risk-free
asset (a one-month U.S. Treasury bill), and adjusted this share to make the volatility of the
optimal portfolio, measured by the standard deviation, equal to that of the non-energy stockindex, which has a standard deviation of 15.7 percent.
24.

After this adjustment, the optimal portfolio that includes energy stocks earned anaverage annualized excess return of 6.3 percent. While lower than the gross return calculated
above, this is still substantially higher than the average return for the divested non-energy index
portfolio, which is only 5.8 percent. This indicates a diversification cost from divesting energy
stocks of approximately 0.5 percent per year, holding constant the volatility of the portfolio.
Exhibit B shows the value over time of $100 invested on January 1, 1965 in each of these two
portfolios. As of December 31, 2014, the $100 invested in the optimal risk-adjusted portfolio
would have grown to about$14,600, whereas the $100 invested in the divested portfolio would
have grown to only about$11,200, indicating a loss of 23 percent due to divestment.
C. Compliance Costs
25.

Our discussion above assumed divestment of all energy stocks, and this would

certainly be a simple divestiture strategy. However, actual divestiture strategies are typically far
more sophisticated, consistent with the complexity of identifying the environmental impact ofindividual companies. For instance, the recent New York Times opinion article described above
proposed that divestiture distinguish between fossil fuel companies: “[i]nvestment could be

11

contingent on a company’s agreeing to curtail its political spending, report on climate change or
include environmental experts on its board.” 25 The Rockefeller Brothers Fund stated that its
process of divestment would involve developing a “detailed plan” over a multi-year period. 26
26.

Investors seeking to pursue climate change sensitive investing would therefore

most likely undertake a careful review to identify securities for divestiture, at a consequently
substantial cost. These costs would likely be ongoing as individual companies’ climate impacts
evolve over time. For example, American University said “divesting from these companies
would require that AU investments be withdrawn from index funds and commingled funds infavor of more actively managed funds [and] estimated this withdrawal would cause manager fees
to double.” 27
27.

It is easy to point at large energy companies as simple targets for divestment, butmany of these companies are also leaders in the production of non-fossil-fuel energy and thedevelopment of green energy technology, so even in these apparently simple cases, investors
would presumably want to exercise nuanced judgment. For instance, from 2000 – 2012, U.S. oiland natural gas companies invested approximately $11.4 billion in renewable sources of energy.
This $11.4 billion contribution accounted for roughly 17 percent of the comparable total industry
and federal government investment during this time period. 28

25.
26.
27.
28.

Evan J. Mandery (2014) “The Missing Campus Climate Debate,” New York Times, November 2, 2014.
Michael Calia (2014) “Rockefeller Fund Seeks to Shed Fossil-Fuel Investments; Family, Whose Fortune isfrom Oil Aims to Limit Bets on Coal, Tar Sands in its Fund,” Wall Street Journal, Sept. 22, 2014.
Jeffrey A. Sine, Chair, Board of Trustees (2014) “Memorandum to American University Community,”
November 21, 2014, http://www.american.edu/trustees/Announcement-November-21-2014.cfm.
Thomas Tanton.(2011) “Key Investments in Greenhouse Gas Mitigation Technologies from 2000 Through2012 by Energy Firms, Other Industry and the Federal Government,” T2 & Associates, at p. 9.

12

28.

Moreover, investors attempting to achieve environmental goals in their portfolio

would also likely want to consider the appropriateness of other companies that produce productsthat are complements for fossil fuels, like automakers or construction companies, and companies
that provide support and services for fossil fuel production, like banks that provide cash
management and lines of credit. Effectively identifying divestiture targets in these cases requiresa fuller understanding of the activities of these firms and how those activities may affectenvironmental outcomes.
29.

Compliance costs associated with divestiture could, in principle, be reduced if

recognized environmental experts could agree upon a unified set of target securities. The cost ofobtaining and maintaining this expert analysis could then be allocated across many investors.
However, at least for now, the lists of companies proposed as targets by major divestment
campaigns diverge widely.
30.

For instance, one of the most prominent divestment campaigns, Fossil Free,

proposes investors divest from securities issued by companies on a list it calls the “Carbon
Underground 200,” which “identifies the top 100 public coal companies globally and the top
public oil and gas companies globally, ranked by the potential carbon emissions content of theirreported reserves.” 29 Another group with similar views, the Political Economic ResearchInstitute, has developed its own list of major polluters, the “Greenhouse 100 Polluters Index,”
which “identifies the top companies responsible for greenhouse gas emissions.” 30 Exhibit C
reports the top 10 U.S. companies on each of these two lists. Despite the apparently sympathetic
goals of these two lists of companies, there is no overlap among even the top 10 firms.
29.
30.

See: http://fossilfreeindexes.com/the-carbon-underground-2014/.
See: http://www.peri.umass.edu/greenhouse100/.

13

31.

Overall, among the 192 unique companies on the Carbon Underground 200, andthe 88 unique companies on the Greenhouse 100 Polluters Index, only 11 companies appear on
both lists.31 This comparison illustrates the complexities that investors will likely need toconsider when choosing to divest, and the consequently higher costs they will incur in doing so.
Principled compliance with a climate change sensitive divestment strategy requires investors tomake thoughtful judgments regarding the securities in their portfolio, and these judgments are
not straightforward or automatic. 32
32.

Moreover, in addition to compliance costs associated with divestment, an investor

would also presumably want to identify other acceptable securities for reinvestment. For
instance, the fossil fuel divestment advocacy group Fossil Free proposes that, after divesting,investors should “focus a reinvestment strategy on renewable energy, energy efficiency, andclimate mitigation and adaptation infrastructure.” 33 However, there is again no simple expert
consensus approach to doing so, and therefore, considerable efforts would be necessary to
identify and support a given investment strategy. In particular, existing mutual funds that doindicate environmental concerns as a key objective vary widely in their holdings. Exhibit D
illustrates the 10 largest security holdings of the five largest such funds by market capitalization.
Thirty-one of the forty unique securities listed in Exhibit D appear in the top 10 security holdings
31.
32.

33.

To determine unique companies and the overlap between the two lists, Capital IQ was used to determine
the parent company associated with the entities on each list.
For example, Trillium Asset Management, a supporter of the 350.org divestment campaign, offers clients
several investment vehicles that hold equities in fossil fuel companies. In particular, its Large Cap Core
fund lists EOG Resources, which is also listed on the Carbon Underground 200, as one of its top 10
holdings. See: http://www.trilliuminvest.com/wp-content/uploads/2014/10/Trillium-Large-Cap-Core-FactSheet-Q3-2014.pdf. Trillium states that “[a]n important piece of Trillium’s climate change strategy is toengage companies on climate change risks.” See: http://www.trilliuminvest.com/wpcontent/uploads/2013/01/Trillium-Fossil-Fuel-Free-Investing.pdf. However, they invest only in funds thatmeet certain “ESG” (environmental, social and governance) criteria. In other words, even an organizationthat supports divestment acknowledges that some fossil fuel firms meet its standard for companies that are“protecting the environment” and “exhibiting best practices.” See http://www.trilliuminvest.com/approachto-sri/esg-integration/.
See: http://gofossilfree.org/usa/your-roadmap-to-personal-divestment/.

14

of only one of these funds. This illustrates that additional costs will be incurred by investors inresearching reinvestment opportunities.
33.

Even if a reliable definition of target divestment securities and appropriate

replacement investments could be identified today, compliance costs are still likely to be
substantial and ongoing for investors. Over time, it is likely that the composition of portfolio
companies’ investments will evolve and their holdings and activity related to fossil fuels willchange. Companies will drift between unacceptable and acceptable status according to various
metrics, many of which are not reliably quantified and/or subjective in nature. Moreover, newpotential investments will arise, which must be continually analyzed relative to the desired
environmental objectives.
34.

There are two ways for an investor to maintain ongoing portfolio compliance withdivestment objectives. One is for the investor to manage the portfolio, continuously monitoring
the activities of the companies within the portfolio to identify divergence from environmental
objectives and adjusting the portfolio correspondingly. A second approach is to outsource thismonitoring by holding a larger share of the portfolio in a mutual fund with “green” objectives;
this essentially entrusts the mutual fund manager with the role of active management. Either
approach involves costs that are likely to be substantial for most investors.
35.

Financial literature has long associated active portfolio management, either

individually or through a mutual fund manager, with a higher overall fee structure relative to
passive strategies. In his 2008 Presidential Address to the American Financial Association,
Kenneth R. French summarized a range of evidence indicating that the cost of active portfolio

15management is a reduction in the average annual return on a portfolio of 0.67 percent per year. 34
Over a 10-year horizon, an initial portfolio of $1,000,000 would experience an average of over
$67,000 in losses due to the cost of active management.
36.

Dr. French’s estimate reflects the overall average costs to investors who actively

manage their portfolios for a wide range of reasons besides environmental concerns, and I am notaware of any estimates in the literature that focus on the costs of active management exclusively
for the purposes of achieving environmental goals. Nevertheless, it is a broadly accepted
principle of financial economics that active investing is costly and involves lower returns formost investors. 35
37.

Even so, management fees for mutual funds with an environmental focus appear

to be, on average, greater than those funds without such a focus. Exhibit E-1 compares the 10
largest “green” mutual funds proposed by The Forum for Sustainable and Responsible
Investment (“US SIF”), a group that seeks to advance investment practices that consider
environmental criteria, with a set of the largest overall mutual funds in the market by assets
under management (as reported by Bloomberg, L.P.). 36 On average, the US SIF green mutual
funds reported an expense ratio of 0.95 percent of assets, approximately three times higher than

34.
35.

36.

This estimate includes certain transaction costs, which I discussed earlier in this report.
http://www.afajof.org/details/video/2870801/2008-Presidential-Address.html.
For example, one prominent textbook states, “[p]roponents of the efficient market hypothesis often
advocate passive as opposed to active investment strategies. The policy of passive investors is to buy andhold a broad-based market index. They expend resources neither on market research nor on frequentpurchase and sale of stocks. Passive Strategies may be tailored to meet individual investor requirements.”
Zvi Bodie, Alex Kane, and Alan Marcus (2014) Investments, Tenth Edition, McGraw Hill/Irwin, at p. 380.
US SIF is one of the resources that divestment advocacy group Fossil Free proposes that investors use to
identify appropriate re-investment assets. See: http://gofossilfree.org/usa/your-roadmap-to-personaldivestment/.

16

the average expense ratio of the 10 largest mutual funds, which was reported at only 0.32 percent
over the same period (see Exhibit E-2). 37
D. The overall cost of divestment is substantial.
38.

While each of the individual costs discussed above is meaningful in isolation,

taken together these costs have the potential to substantially impair the future value ofendowments and other investor funds. For example, a 0.5 percent decrease in portfolio
performance impact on the estimated $456 billion in university endowment assets would
decrease annual growth by over $2 billion annually. 38 An increase in compliance costs of 1
percent on the estimated $23 billion of those endowments invested in energy stocks would
further decrease annual growth by an additional $230 million. 39 A reduction in wealth of thismagnitude could have a substantial impact on the ability of universities to achieve their goals,
such as the research, scholarships and services that universities are able to offer. As noted by
Harvard President Drew Faust,“Significantly constraining investment options risks significantly constraining
investment returns. The endowment provides more than one-third of the funds we
expend on University activities each year. Its strength and growth are crucial to
our institutional ambitions — to the support we can offer students and faculty, tothe intellectual opportunities we can provide, to the research we can advance.” 40

37.
38.

39.
40.

These calculations are based on the most recent data provided by Morningstar.
See, “U.S. and Canadian Institutions Listed by Fiscal Year 2013 Endowment Market Value and Change inEndowment Market Value from FY 2012 to FY 2013,” Revised February 2014(http://www.nacubo.org/Documents/EndowmentFiles/2013NCSEEndowmentMarket%20ValuesRevisedFe
b142014.pdf).
Id.,.and The 2013 Commonwealth Study of College Endowments.
Drew Faust, Harvard University Office of the President (2013) “Fossil Fuel Divestment Statement,”
October 3, 2013, http://www.harvard.edu/president/fossil-fuels.

17

III.

Divestiture is unlikely to impact equity values of divested companies or achieve
other goals.
A. Divestiture is unlikely to impact equity values of divested companies.
39.

The ostensible purpose of divestment would be to place capital market pressure

on certain companies to reduce or change business operations that activists believe may harm theenvironment or impact climate change. However, basic and widely-accepted financial principles
indicate that divestment is in fact highly unlikely to have any substantial effect on thesecompanies.
40.

Financial analysts typically represent the price of a stock as the present value ofthe expected returns to the company’s investments. 41 In highly liquid markets, a company’s
stock price cannot diverge in any persistent, substantial way from this fundamental value,
because otherwise, investors would have the opportunity to earn greater returns by buying or
selling the stock, a process known as arbitrage. As one textbook puts it, “[t]he idea that market
prices will move to rule out arbitrage opportunities is perhaps the most fundamental concept incapital market theory.” 4241.

This relationship between a company’s stock price and its fundamental value inliquid markets means that divestment campaigns cannot materially affect stock prices andtherefore cannot materially change a company’s incentives to undertake certain activities or otherinvestors’ incentives to hold these companies in their portfolios. As an example, suppose aparticular company’s stock price is currently $100. While individual investors can and do differ
41.
42.

Richard A. Brealey, Stewart C. Myers, and Franklin Allen (2014) Principles of Corporate Finance (11thed.), McGraw-Hill Irwin, pp. 80-84.
Zvi Bodie, Alex Kane, and Alan J. Marcus (2014) Investments, Tenth Edition, McGraw-Hill Irwin, at p.
328. See also Hal R. Varian (2014) Intermediate Microeconomics (9th ed.), W.W. Norton & Co., at p. 205(stating, “[a]s long as there are people around looking for ‘sure things’ we would expect that wellfunctioning markets should quickly eliminate any opportunities for arbitrage.”)18

in their beliefs about a company’s future profitability, the $100 price can be thought of as amarket consensus view about the value of future profits and dividends for the company.
42.

An investor who wishes to divest his portfolio of this stock would offer it for saleand (putting aside the bid-ask spread) be able to sell the stock for approximately $100 per share,with no reduction in the stock price, because if the stock price did decline, say to $95, otherinvestors would be able to earn $5 per share in arbitrage profits. This would lead other investors
to bid up the price back to $100. This is the simple logic of arbitrage that implies that divestiturecannot materially reduce equity values. 43
43.

As described above, institutions currently engaged in fossil fuel divestment arefocused among the educational, philanthropic, and government sectors, and these institutions
hold a very small share of stock in the targeted companies. Even a substantially morewidespread adoption of divestment policies by these types of institutions would therefore havelittle or no effect on share prices. As noted above, for instance, available estimates indicate thatcollege and university endowments have roughly $23 billion invested in energy and natural
resources. This is less than 1 percent of the more than $3.8 trillion in total current market
capitalization of the 200 companies on the Carbon Underground 200. 44
B. Prior divestment campaigns have not impacted stock valuations.
44.

The conclusion that divestiture campaigns are unlikely to affect targetedcompanies is confirmed by the experience of prior campaigns. During the 1980s, a major
43.
44.

In theory, it could be possible for divestment to affect the price of a security that was highly illiquid,because of the lack of arbitrageurs. However, the stocks of most major companies targeted by divestment
campaigns are traded on exchanges and have liquid markets for their equity.
Total current market capitalization is calculated as of year-end (12/31/2014), sourced from available dataon Bloomberg, L.P.

19

coordinated divestiture campaign targeted securities issued by companies with interests in South
Africa, with the goal of supporting an end to Apartheid. By 1986, over 100 colleges anduniversities had adopted some form of South African divestment, as had the pension funds ofseveral states, including New Jersey and California, and major companies, including Lotus
Development and Levi-Strauss. 45 In addition to being widely adopted by many institutional
investors, South African divestment is a far more narrowly-defined investment strategy with far
less controversial goals than fossil fuel divestment. Therefore, South African divestment would
be more likely to succeed in affecting change at the targeted companies.
45.

Nevertheless, available evidence indicates that South African divestment had little

or no impact on the stock prices of targeted companies. A 1996 article used an event study
methodology to investigate whether South Africa divestiture announcements by major
institutional investors, including municipalities, states, and universities, impacted stock returns offirms that chose to maintain their presence in South Africa during the 1983-1989 period. 46 The
authors concluded that “[i]t appears that portfolio divestment announcements by major pension
funds and endowment associations had no important impact on stock prices of firms doing
business in South Africa.” 47
46.

Another study examined the stock price reactions of firms with high levels of

exposure in South Africa on 21 dates when pension funds announced policies of divestment. 48
45.
46.
47.
48.

William H. Kaempfer, James A. Lehman, and Anton D. Lowenberg (1987) “Divestment, Investment
Sanctions, and Disinvestment: An Evaluation of Anti-Apartheid Policy Instruments,” International
Organization 41(3):457-73, at 460-461.
Laurian Casson Lyttle and O. Maurice Joy (1996) “The Stock Market Impact of Social Pressure: The South
African Divestment Case,” Quarterly Review of Economics and Finance, 36(4):507-527.
Id., at 519.
Siew Hong Teoh, Ivo Welch, and C. Paul Wazzan (1999) “The Effect of Socially Activist Investment
Policies on the Financial Markets: Evidence from the South African Boycott,” Journal of Business
72(1):35-89.

20

The authors found that these firms suffered no statistically significant effect on their stock prices
on 16 of these 21 dates, experienced statistically significant and negative effects on three dates,and experienced statistically significant and positive effects on two dates. 49 On the basis of thisevidence, they concluded that the evidence “does not indicate that the pension fund divestment
announcement significantly hurt firms with major South African operations.” In summary, theystated, “the announcement of legislative or shareholder pressure had no discernible effect on thevaluation of banks and corporations with South African operations or on the South African
financial markets.” 50
47.

Another study that included a broader range of divestment campaigns, including

those related to South Africa as well as others, concluded that “[d]ivestitures do not seem tomotivate change” at targeted companies and “divestiture announcements resulted in no
significant market responses.” 51
48.

Even if, contrary to financial economic theory and all the available evidence, adivestiture campaign could effect change in the activities of target companies by lowering theirstock prices, divestment proponents should consider the harm this reduction in stock prices
would cause. For instance, ExxonMobil’s common stock is among the most widely-held equity
issues in the world. Its largest current shareholders are top investment managers and institutional

49.
50.
51.

These results are based on the “Equal Weighted” model. Other models presented by the author, including“Sales Weighted,” “Asset Weighted,” and “Employee Weighted” indicate even fewer dates withstatistically significant and negative effects. Id., at 64-67.
Id., at 68, 79 and 83.
Wallace N. Davison, III, Dan L. Worrell, & Abuzar El-Jelly (1995) “Influencing Managers to Change
Unpopular Corporate Behavior Through Boycotts and Divestitures: A Stock Market Test,” Business &Society 34(2):171-196, at pp. 171 & 190.

21

investors, including CalPERS, the New York State Common Retirement System, and both the
New York and California Teachers’ Retirement Systems. 52
49.

In fact, according to a study published in October 2014, pension funds are thelargest category of owners of U.S. oil and natural gas companies, holding approximately 28.9
percent of all oil and natural gas company shares. 53 With individual investors holding an
additional 36.6 percent of all shares (including shares held in IRAs), the study’s analyses “showthat middle-class households dominate the ownership of U.S. publicly-held oil and natural gas
companies…[and] benefit from the industry’s strong returns.” 54 This same study estimates thatpension plans and IRAs hold approximately $909 billion in oil and natural gas company stock.
If divestment proponents were successful in reducing the returns on these investments by 1
percent each year, relative to what they would have been otherwise, retirees and other individual
investors would lose more than $90 billion in value over the next 10 years.
C. Divestiture is unlikely to change social views regarding environmental goals.
50.

The inability of divestment campaigns to directly affect company activity isunderstood, even by divestiture proponents. For instance, the divestiture proponent organization
Fossil Free readily admits that divestment “[is not] primarily an economic strategy, but a moral
and political one.” Fossil Free acknowledges that divestment is a tactic primarily intended to“spark[] a big discussion,” and “might not have an immediate impact on a fossil fuelcompany.” 55 Similarly, leaders of Divest Harvard have stated that “[w]e do not expect

52.
53.
54.
55.

As of 9/30/2014. Data from Thomson Financial.
Robert J. Shapiro & Nam D. Pham (2014) “Who Owns America’s Oil and Natural Gas Companies: A 2014
Update,” Sonecon, at pp. 1-2.
Id,. at 2.
See: http://gofossilfree.org/usa/frequently-asked-questions/.

22

divestment to have a financial impact on fossil fuel companies … Divestment calls on citizens tobuild a powerful climate movement and pressure elected representatives to enact meaningful
legislation.” 56
51.

Obviously, climate change is one of the most controversial issues in public

discourse today, and the range of opinions about it is very wide. Even ignoring the broader
range of opinions and focusing solely on the economic debate, a recent survey of the economic
literature concluded there was “considerable uncertainty about the economic impact of climatechange,” and “large estimated uncertainty about the social cost of carbon.” 57 Of course, even if
these debates could be resolved, there would still be vociferious debate about the appropriate roleof governments and private actors in policymaking. No matter where one stands on the science,
economics, and policy of the climate change debate, there is no basis to believe that divestment
will help resolve these issues or push the debate materially in any productive direction.
52.

Even for those strong believers in the need to address climate change, thedivestiture proposition serves as more of a distraction than a contributor to public discourse
designed to further real, meaningful solutions to the problem. As one such strong proponent, thePresident of Harvard University, has recognized:“While I share their belief in the importance of addressing climate change, I do
not believe, nor do my colleagues on the Corporation, that university divestment
from the fossil fuel industry is warranted or wise…Because I am deeply
concerned about climate change, I also feel compelled to ask whether a focus on

56.
57.

Chloe Maxmin, Hannah Borowsky and StudentNation (2014) “The Time to Divest: A Response to Harvard
President Drew Faust,” The Nation, October 15, 2013.
Richard S. J. Toll (2009) “The Economic Effects of Climate Change,” Journal of Economic Perspectives
23(2):29-51, at pp37, & 42.

23

divestment does not in fact distract us from more effective measures, betteraligned with our institutional capacities.” 58
53.

Indeed, fossil fuel divestment is not needed to “spark[] a big discussion” aboutclimate change, or generate increased public interest in climate change policymaking. The
climate change debate is already a major part of the news and policy discussion in the UnitedStates and other countries. During 2013, climate change was the most commonly covered
environmental story on the major networks’ evening newscasts. 59
54.

The debate regarding climate change is also highly prominent in major

newspapers. During 2014, 2,118 news articles in the five largest circulation newspapers in the
United States referenced “climate change” or “global warming.” 60 This is almost the same as thenumber of news articles in these papers that referenced “Ebola” (2,167 articles) and not much
fewer than the number of news articles in these papers that referenced “Obamacare” or“Affordable Care Act” (2,727). The climate change debate has been prominent in public
discourse for more than two decades, while the Ebola outbreak and health insurance legislation
stories are far more temporary news events. Therefore, one would expect climate change stories
to be less frequent; nevertheless, as these statistics show, climate change controversies areclearly not suffering from a lack of prominent news coverage, relative to other major newsgenerating stories.

D. Divestiture is unlikely to accomplish investment goals.

58.
59.
60.

Drew Faust, Harvard University Office of the President (2013) “Fossil Fuel Divestment Statement,”
October 3, 2013, http://www.harvard.edu/president/fossil-fuels.
Tyndall Report Year in Review, 2013, http://tyndallreport.com/yearinreview2013/environment/.
This study was performed using the Dow Jones / Factiva service, and covered the period December 31,
2013 through December 22, 2014. The newspapers included were: Wall Street Journal, New York Times,
USA Today, Los Angeles Times, and New York Daily News.

24

55.

Some proponents of divestment hold that fossil fuel company stocks are likely tosuffer reductions in price over time, and therefore, that divestment is a successful investment
strategy, regardless of its impact on environmental goals. For instance, Fossil Free claims that“investing in clean energy, efficiency, and other sustainable technologies can be even more
profitable than fossil fuels.” 61
56.

As discussed above, this claim is demonstrably false over the past 50 years. As

we showed, over the 1965-2014 period, a portfolio including both an energy sector stock index
and non-energy stocks experienced a 0.7 percent higher gross return, and a 0.5 percent higher
risk-adjusted return, relative to a divested portfolio of only the non-energy stock index.
57.

Of course, everyone is entitled to their own opinion about the future course of

security prices, and it is certainly possible that, over some period, stocks of fossil fuel companies
will underperform other stocks. But unless an investor has private information about thesecompanies which is unavailable to other market participants (and I am not aware that any
divestment proponents claim they do have such private information), there is no reason toassume that their current stock prices are “too high” or that they will inevitably decline. 62
58.

While there is a long-running and wide-ranging debate among academics about

whether securities markets are “efficient” in one form or another, there is neverthelesswidespread agreement that simple rules like “sell fossil fuel stocks” are not recipes for making

61.
62.

http://gofossilfree.org/usa/frequently-asked-questions/.
This applies to the discussion among some divestment advocates of “stranded assets,” i.e., company assetsthat could become uneconomical to exploit at some point in the future due to changes in market prices or
future regulations related to climate change. Divestment advocates do not claim to have private
information about these changes in prices or regulations that are not available to the investing public atlarge; therefore, current security prices already incorporate the market consensus view about stranded
assets.

25

money. As one textbook puts it, “[t]he bulk of the evidence, however, suggests that any
supposedly superior investment strategy should be taken with many grains of salt. The market iscompetitive enough that only differentially superior information or insight will earn money; theeasy pickings have been picked.” 63IV.

Conclusion
59.

The economic evidence demonstrates that fossil fuel divestment is a bad idea.

The costs of divestment are clearly substantial. Trading costs like commissions are incurred in
virtually every securities transaction. Costs associated with reductions in diversification are a
bedrock principle of financial economics. Ongoing compliance costs mean that every future
securities transaction will need to be analyzed for its environmental impact. These costs havereal financial impacts on the returns generated by an investment portfolio, and therefore, real
impacts on the ability of an educational institution to achieve its goals.
60.

By contrast, any benefits from fossil fuel divestment are likely to be non-existent.

There is no basis to believe that divestment can affect the stock prices or business decisions oftargeted firms. Moreover, there is broad agreement among financial professionals and academics
that simple investment rules like divestment from fossil fuel companies cannot generate superior
returns. Finally, divestment seems unlikely to affect the public debate or provide an effective
tool even for those who strongly feel the need to address climate change.

63.

Zvi Bodie, Alex Kane, and Alan J. Marcus (2014) Investments, Tenth Edition, McGraw-Hill Irwin, at p.
380.

26

Exhibit A: Correlation of Each Sector With Other Nine Sectors
Sector
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.

EnergyUtilities
Healthcare
Telecommunications
DurablesHigh-Technology
Shops
Non-Durables
Other
Manufacturing

Correlation
0.67700.70460.77440.81380.82480.82590.86070.86420.90770.9183

Notes: For each sector, a value-weighted index of all stocks in that sector and a value
weighted index of all stocks in the other nine sectors were created. The correlation between
the excess returns of those two indices are shown in the Exhibit.
Source: CRSP.

Exhibit B: Optimal Risk-Adjusted Portfolio vs. Divested Portfolio
1965-2014$18,000$16,000$14,000

As of December 31, 2014
Divested Portfolio: ~$11,200
Optimized Portfolio: ~$14,600
With the same amount of risk as the divested
portfolio, the optimized portfolio added an
additional $3,400 in return over 50 years.

Value of $100

$12,000$10,000$8,000$6,000$4,000$2,000$0

Optimal Risk-Adjusted Portfolio
Divested Portfolio
Notes:[1] The indices are value-weighted by market capitalization.
[2] The Optimal Risk-Adjusted Portfolio is comprised of the energy index and 1-month Treasury bill, optimized by matching the standard deviation of the Divested
Portfolio.
[3] The Divested Portfolio is comprised of only the non-energy index.
Sources: CRSP; Kenneth R. French.

Exhibit C. Top 10 Coal and Oil & Natural Gas Companies
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.

Carbon Underground 200
Peabody Energy
ExxonMobil
Arch Coal
Alpha Natural Resources
ChevronCloud Peak Energy
ConocoPhillips
Consol Energy
Nacco Industries
Alliance Resource Partners

Greenhouse 100 Polluters Index
American Electric PowerDuke Energy
Southern Company
Berkshire Hathaway
AmerenLuminant
FirstEnergy
AES
Xcel Energy
Dominion Resources

Notes:[1] The Carbon Underground 200 and Greenhouse 100 Polluters Index have been restricted to include
only U.S. companies.
[2] All non-corporate entities have been removed.
Source: Carbon Underground 200; Bloomberg, L.P.; Political Economy Research Institute.

Exhibit D. Top 10 Holdings for Five Largest “Green” Mutual Funds
Neuberger Berman
Socially Responsive FundPax World Balanced FundJohnson & Johnson

Texas Instruments

Apple Inc.

Apple Inc.

Berkshire Hathaway Inc.

Newell Rubbermaid

BlackRock Inc.

Motorola Solutions

Gilead Sciences Inc.

Procter & Gamble Co.

American Express Co.

UnitedHealth Group Inc.

4.

Pentair PLC

The Coca Cola Co.

Verizon Communications Inc.

Danaher Corp.

Becton Dickinson & Co.

5.

Procter & Gamble Co.

Costco Wholesale Corp.

Progressive Corp.

Microsoft Corp.

6.

Iron Mountain Inc.

Visa Inc.

International Business
Machines Corp.
Intel Corp.

Morgan Stanley

7.

Qualcomm Inc.

Qualcomm Inc.

Merck & Co Inc.

Intercontinental Exchange
Inc.
TJX Cos.

8.

Apple Inc.

Lowe’s Companies Inc.

Gilead Sciences Inc.

Robert Half International

Hess Corp.

9.

Mondelez International Inc.

Google Inc. (Class A)

U.S. Bancorp

American Express Co.

10.

CVS Health Corp.

Intercontinental ExchangeInc.
Wells Fargo & Company

Google Inc.

eBay Inc.

Intel Corp.

Parnassus Core Equity
Fund

Calvert Equity Portfolio

1.

Allergan Inc.

CVS Health Corp.

2.

Applied Materials

3.

TIAA-CREF Social Choice
Equity Fund

Merck & Co Inc.

Note:
[1] Companies in bold appear in multiple mutual funds.
[2] Treasury holdings have been excluded.
[3] TIAA-CREF and Pax holdings data are as of 9/30/2014, the remaining holdings data are as of 11/30/2014.
Sources: The Forum for Sustainable and Responsible Investment (http://charts.ussif.org/mfpc/); GoFossilFree.org (http://gofossilfree.org/usa/your-roadmap-topersonal-divestment/); Parnassus (http://www.parnassus.com/parnassus-mutual-funds/core-equity/investor-shares/portfolio); Calvert(http://www.calvert.com/fundprofile.html?fund=919); TIAA-CREF (https://www.tiaa-cref.org/public/tcfpi/Investment/Profile?symbol=4530792); Neuberger
Berman (http://www.nb.com/Pages/public/en-us/products/socially-responsive-fund.aspx); Pax(http://www.paxworld.com/system/storage/14/a0/3/773/fact_sheet_balancedfund.pdf).

Exhibit E-1. Associated Costs for 10 Largest Mutual Funds
Fund
Vanguard Total Stock Market Index Fund
Vanguard Institutional Index Fund
Vanguard 500 Index FundPIMCO Total Return FundThe Growth Fund of America
Vanguard Prime Money Market Fund
Vanguard Total International Stock Index Fund
EuroPacific Growth Fund
J.P. Morgan Prime Money Market Fund
Fidelity Cash Reserves

1.
2.
3.
4.
5.
6.
7.
8.
9.
10.

Average

Notes:[1] The Bahana Liquid USD Fund was dropped because primary documents could not be located.
[2] “Expense Ratio” uses the most recent annual data from Morningstar.
Sources: Bloomberg, L.P.; Morningstar.

Expense Ratio
0.17%
0.04%
0.17%
0.46%
0.66%
0.14%
0.22%
0.84%
0.23%
0.28%
0.32%

Exhibit E-2. Associated Costs for “Green” Mutual Funds
Fund
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.

Parnassus Core Equity FundCalvert Equity Portfolio
TIAA-CREF Social Choice Equity
Neuberger Berman Socially Responsive FundPax World Balanced Fund
Ariel Appreciation Fund
Ariel Fund
CRA Qualified Investment Fund
Domini Social Equity FundCalvert Balanced Portfolio
Average

Expense Ratio
0.87%
1.11%
0.35%
1.12%
0.91%
1.12%
1.03%
0.75%
1.02%
1.25%
0.95%

Notes:[1] Where the Forum for Sustainable and Responsible Investment presents multiple investor classes of the same fund as having thesame Assets Under Management, “Expense Ratio” is the average expense ratio across investor classes.
[2] “Expense Ratio” uses the most recent annual data from Morningstar.
Sources: The Forum for Sustainable and Responsible Investment; Morningstar.

APPENDIX A: KEY QUALIFICATIONS OF DANIEL R. FISCHEL

1.

I am President of Compass Lexecon, a consulting firm that specializes in theapplication of economics to a variety of legal and regulatory issues. I am also the Lee and Brena
Freeman Professor of Law and Business Emeritus at The University of Chicago Law School. I
have served previously as Dean of The University of Chicago Law School, Director of the Law
and Economics Program at The University of Chicago, and as Professor of Law and Business at
The University of Chicago Graduate School of Business, the Kellogg School of Management at
Northwestern University, and the Northwestern University Law School.
2.

Both my research and my teaching have concerned the economics of corporate

law and financial markets. I have published approximately fifty articles in leading legal andeconomics journals and am coauthor, with Judge Frank Easterbrook of the Seventh Circuit Courtof Appeals, of the book The Economic Structure of Corporate Law (Harvard University Press,
1991). Courts of all levels, including the Supreme Court of the United States, have cited myarticles as authoritative. My curriculum vitae, which contains a list of my publications, isavailable on the Compass Lexecon website at http://www.compasslexecon.com/.
3.

I have served as a consultant or adviser on economic issues to, among others, theUnited States Department of Justice, the United States Securities and Exchange Commission, theNational Association of Securities Dealers, the New York Stock Exchange, the Chicago Board ofTrade, the Chicago Mercantile Exchange, the New York Mercantile Exchange, the United States
Department of Labor, the Federal Deposit Insurance Corporation, the Resolution Trust
Corporation, the Federal Housing Finance Agency, and the Federal Trade Commission.

1

4.

I am a member of the American Economic Association and the American Finance

Association. I am also a member of the Board of Governors of the Becker Friedman Institute at
the University of Chicago and an Advisor to the Corporate Governance Project at Harvard
University. I am also a former member of the Board of Directors of the Center for the Study of
the Economy and the State at The University of Chicago, and former Chairman of the American
Association of Law Schools’ Section on Law and Economics. I have testified as an expert
witness in multiple proceedings in federal and state courts across the country.

2

APPENDIX B: MEAN-VARIANCE ANALYSIS OF ENERGY STOCK DIVESTMENT

1.

We make use of a common analytical framework used by financial analysts

known as Mean-Variance Analysis. 1 We will show that by adding energy stocks to a market
portfolio that is divested from the energy sector, one can achieve a substantially higher return
over the 1965-2014 period without increasing the variance of the portfolio.
2.

Mean-Variance Analysis reflects a typical investor’s desire to build a portfoliothat has high and stable returns, recognizing that there is a tradeoff between those two goals.
Some investors are willing to accept a higher level of period-to-period volatility in returns, whileothers are not. The basic principle of Mean-Variance Analysis is that, for any given level of
period-to-period volatility in portfolio return, an investor should choose the portfolio thatmaximizes average excess returns (relative to a “risk-free” asset, like U.S. Treasury bills). For
example, if an investor is willing to accept a level of volatility in his portfolio such that thestandard deviation in excess returns over time is 2 percent, then a portfolio with that 2 percent
volatility measure and an average excess return of 3 percent is suboptimal if another portfoliowith the same standard deviation but an average excess return of 4 percent exists.
3.

Investors can achieve the maximum average return for a given volatility level by

maximizing the “Sharpe Ratio” of the portfolio of risky assets, i.e., excluding any risk-free
assets. 2 The Sharpe Ratio is defined as:
𝑀𝑀𝑀𝑀(𝐸𝐸𝐸𝐸𝐸𝐸 𝑅𝑅𝑅𝑅𝑅𝑅𝑅)

Sharpe Ratio = 𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆 𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷(𝐸𝐸𝐸𝐸𝐸𝐸 𝑅𝑅𝑅𝑅𝑅𝑅𝑅),
1.
2.

See: Zvi Bodie, Alex Kane, and Alan J. Marcus (2014) Investments, Tenth Edition, McGraw-Hill Irwin, at
p. 208.
Id., at pp. 134.

1

where excess returns is the calculated return of the portfolio relative to the return of the risk-free
asset.
4.

After selecting stocks to maximize the Sharpe Ratio, the investor can then add

risk-free assets like U.S. Treasury bills to the portfolio to reduce its volatility as desired without
reducing the Sharpe Ratio of the portfolio. In this way, the investor can achieve the highest
expected return of the portfolio for a given level of volatility.
5.

To estimate the diversification cost associated with restricting energy stocks fromthe portfolio, we constructed a value-weighted energy stock index from the CRSP database, as
discussed in the text. Separately, we also constructed a single value-weighted index of all nonenergy stocks in the other nine sectors. The means and standard deviations of the two indicesover the 1965-2014 period are reported below in Table 1.

Table 1: Properties of Energy and NonEnergy Indices
Excess Returns
MeanStandard Deviation
Sharpe Ratio

Non-Energy Index
5.77%
15.71%
0.3674

Energy Index
7.44%
20.25%
0.3674

Notes: “Energy” refers to the value-weighted index of all
stocks in the Energy Sector. “Non-Energy” refers to thevalue-weighted index of all stocks not included in the
Energy Sector.
Sources: CRSP; Kenneth R. French.

2

6.

As can be seen in the Table, the Energy Index has higher average returns, but also

a higher standard deviation, indicating greater volatility. Regardless of whether an investor iswilling to take on greater volatility or not, including the Energy Index in the portfolio in at least
some quantity generates diversification benefits because the Energy and Non-Energy indices are
not perfectly correlated. In particular, the correlation coefficient between the two indices is0.6770.To demonstrate this, we calculated the Sharpe Ratio for portfolios which combined theEnergy Index and the Non-Energy Index with different weightings on each index. The portfolio
including both energy and non-energy stocks that maximizes the Sharpe Ratio contains anallocation of 56.3 percent to the Non-Energy Index and 43.7 percent to the Energy Index. Table
2 below compares the Non-Energy index (i.e., the divested portfolio) to the optimal portfolio
including both indices.

Table 2: Properties of the Optimal Risky Portfolio
Excess Returns

Optimal Risky Portfolio

Divested Portfolio

MeanStandard Deviation
Sharpe Ratio

6.50%
16.20%
0.4012

5.77%
15.71%
0.3674

Notes: Two value weighted indices were created: the first contains allenergy stocks, and the second contains all non-energy stocks in CRSP.
“Optimal Risky Portfolio” refers to the combination of the value
weighted indices that maximizes Sharpe Ratio, and “Divested
Portfolio” refers to the portfolio that contains only non-energy stocks.
Sources: CRSP; Kenneth R. French.

7.

Consistent with our findings above regarding the Energy Index, the optimal

portfolio including both indices has a higher average return, but also a higher standard deviation.
We can now add a risk-free asset to the optimal portfolio including both indices until its
volatility matches that of the divested portfolio. The risk-free asset for this analysis is the one3

month U.S. Treasury bill. As discussed above, the Sharpe Ratio of the portfolio is not affectedby the addition of a risk-free asset. Specifically, by moving 3.04 percent of the combined energy
and non-energy portfolio to the risk-free asset, the volatility of the portfolio can be made tomatch the volatility of the divested portfolio, with a standard deviation of 15.71 percent.
8.

As shown in Table 3, despite having the same volatility as the divested portfolio,

the portfolio that includes energy stocks earned an average return of 6.30 percent, whereas thedivested portfolio earned an average return of only 5.77 percent. The difference between these
two mean returns, 0.53 percent, is a measure of the portfolio diversification cost of divestingfrom energy stocks, holding portfolio volatility constant.

Table 3: Properties of the Optimal Risk-Adjusted Portfolio
Excess Returns
MeanStandard Deviation
Sharpe Ratio

Optimal Risk-Adjusted Portfolio
6.30%
15.71%
0.4012

Divested Portfolio
5.77%
15.71%
0.3674

Notes: Two value weighted indices were created: the first contains all energy
stocks, and the second contains all non-energy stocks in CRSP. “Optimal RiskAdjusted Portfolio” refers to the combination of the value weighted indicesand the risk free asset that maximizes Sharpe Ratio and matches the standard
deviation of the Divested Portfolio, and “Divested Portfolio” refers to theportfolio that contains only non-energy stocks. The risk free return is the daily
return of the treasury bills.
Sources: CRSP; Kenneth R. French.

9.

While the above optimization shows that there is an allocation to energy stocks

that improves portfolio performance, it should also be noted that the value weighted index
created from all stocks in CRSP with an SIC code, i.e. the “market index,” has a higher Sharpe

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Ratio than the divested index considered above. Therefore, the market index will also provide alarger risk-adjusted return than the divested index. These results are reported in Table 4.

Table 4: Properties of Energy and Non-Energy
Indices
Excess Returns
MeanStandard Deviation
Sharpe Ratio

Non-Energy Index
5.77%
15.71%
0.3674Market Index
5.86%
15.70%
0.3732

Notes: “Non-Energy” refers to the value-weighted index of all
stocks not included in the Energy Sector. “Market” refers to
the value-weighted index of all stocks in the CRSP databasethat were assigned an SIC code.
Sources: CRSP; Kenneth R. French.

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