Choice and divestment

The “consumer” activist group Choice have a very uncritical article on a recent Australia Institute Report.

Screening out fossil fuel producers and related companies doesn’t mean you’ll have to accept lower returns on your investments, according to the Australia Institute’s calculations. It compared a portfolio of a specially selected group of ASX 200 companies whose business model doesn’t depend on fossil fuel with the full ASX 200 list over a projected 10-year period. The findings? Getting rid of fossil fuel-related investments had “no significant impact” on returns.

We have discussed this particular report before but it worth revisiting.

This is how the Australia Institute describe their methodology:

We used these classifications to make ‘fossil free’ portfolios by screening out Tiers from the ASX 200. First we eliminated Tier 1 and Tier 2 companies from the ASX 200. Using this screen, US analysts Aperio group constructed an ‘optimised’47 portfolio excluding these stocks and simulated performance based on historic data. The portfolio tracked the broad share market very closely, achieving very similar month to month returns to the ASX 200.

In plain language – they started off with the ASX 200 and deleted 21 firms and then re-optimized the weights of the remaining firms to mimic the portfolio return of the original 200 firms. They then claim:

These results suggest that screening out fossil fuel extraction and downstream industries can have negligible impact on risk-adjusted returns.

First a quibble – the Australia Institute do not claim “no significant impact” – that does have a distinct meaning. Rather it says “negligible impact”. The Australia Institute report indicates a tracking error of 0.88%. This is what I said last time:

Considered negligible by whom? I hunted around for some benchmarks for tracking error and found this – it’s a bit dated, but damning.

An annual study by investment dealer Morgan Stanley found that the average tracking error for U.S.-listed ETFs (excluding inverse and leveraged versions) was 0.52% in 2008. If this average is weighted by assets under administration, the average comes in lower, at 0.39%.

So the tracking error just from screening fossil fuels is 0.88% while the overall average tracking errors for passive funds is 0.39% – 0.52%?

The far greater problem is that the methodology involves what finance academics call look-back bias. They have optimised known returns, after the fact, to replicate the performance of an index. The secret to success, however, is to optimize the performance of a portfolio using unknown returns, before the fact, to replicate the future performance of an index. In other words, there is no reason to believe that actual investors could do as well as the simulation suggests they can given the actual information that they would have available to them when making decisions. In the case of perfect information excluding the fossil fuel firms would result is investors under-performing the ASX 200 and have a tracking error of 0.88%.

Not only have Choice misrepresented a dodgy study, they don’t understand just how dodgy the results are.

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42 Responses to Choice and divestment

  1. nerblnob

    What on earth are they on about? Every company depends on fossil fuels. How does “Choice” distribute its magazines and run its website?

  2. brc

    All indexes have a in-built survivor bias – if your firm starts to struggle, you’ll get dropped from the index and replaced with a new one. Thus the ASX 200 is never the same over time. So hind casting results like this locks in that survivor bias – which is all well and good – but if you try and build a non-fossil fuel portfolio for the next ten years, you can’t tell how many of your stocks will get dropped out of the index going forward.

    The funny thing is all those industry super ads which forward-project the difference in management fees – 0.88% difference does make a difference over 20 years or more.

    If investing money for the future, then you should look for the best returns. You can leave the moral preening to hashtag activism and achieve the same result, but perhaps a little richer in 10 years time. Divesting from fossil fuels doesn’t hurt the company unless everyone – and I mean every single person with capital – from doing it. Even if big funds decided not to invest there are plenty of other investment dollars to take their place.

    But it’s not surprising for people who think that Australia can save the planet by taxing its productive capacity might also think oil companies can be put out of business by selling their shares.

  3. A poorly phrased or partisan survey question (perhaps push-polling):

    If universities are investing in fossil-fuel companies that damage the environment, such as coal and coal seam gas [sic] should they stop these investments?

  4. Art Vandelay

    Not only have Choice misrepresented a dodgy study, they don’t understand just how dodgy the results are.

    Choice is full of economic illiterates so it’s not surprising that virtually every policy position they endorse is bad for competition and consumers.

  5. Not only have Choice misrepresented a dodgy study, they don’t understand just how dodgy the results are

    Surely this bends professional ethics to the breaking point enough that a complaint to your professional licencing body needs to be made aware? After all, people will make investment decisions based on the knowledge in the market.

  6. Petros

    Like any analysis of the stock market, does it take into account new capital invested into a company? It’s easier to show growth in a company if someone is tipping in more dosh. Yes, they need to raise it somehow but it becomes very difficult to compare performances.

  7. johanna

    From first principles, the notion that an investment portfolio should be based on anything but applying the same economic criteria to all stocks is inherently flawed.

    All companies are not equal.

  8. Bruce of Newcastle

    If Choice had an investment report from the Marxist University of Havana would it be considered credible?

    The Australia Institute is run by people with identical politics. Richard Denniss is a past advisor of Bob Brown. The rest of them are also pure grade progressive greens or fellow travellers. So either Choice is staffed by naïve and credulous babes in the woods or they have been colonised by lefties too.

    I lean towards the second alternative.

  9. Myrrdin Seren

    Bruce of Newcastle

    I plump for your Option 2 as well.

    I note in support, the lamestream TV news and current affairs shows regularly find a spin to lambaste some major retailer or another for their claimed predatory abuse of the lowly consumers.

    ( Which, as an aside, is an ironic editorial line given how much those same TV stations rely on those same retailers to pay their salaries ).

    Inevitably the Choice spokescadre is called in to reassure the punters that they are indeed mere prey for the vultures of retail commerce. Subtext – ‘wouldn’t you all be better off with a friendly, government-controlled ministry of food supplying all your needs on a just and ecologically sustainable basis ?!’

    I can only assume there is an odd demographic that likes to be told all day long what victims of capitalism they are, and to which advertisers want to get their wares in front of.

  10. wreckage

    I don’t think excluding gas or oil from your portfolio will necessarily hurt it, unless you replace those stocks with green energy, in which case, you’re boned. Also if you exclude resources you’re out by an entire sector, leaving you way more vulnerable to bubbles and busts elsewhere.

  11. 3d1k

    The Australia Institute works backwards: Start with the answer you want then massage data to fit the result.

    Their reports are rarely worth sharing.

  12. michaelfstanley

    Sinc – if I wanted to guess how a diverse fund would perform against a similar but fossil-free fund, what could I do instead? Is there a better way of doing it than the Australia institute did or is it fundamentally unknowable?

  13. michaelfstanley

    I’m genuinely interested

  14. wreckage

    I can only assume there is an odd demographic that likes to be told all day long what victims of capitalism they are, and to which advertisers want to get their wares in front of.

    The species is distinguished by silver tails and dick heads.

  15. cohenite

    So either Choice is staffed by naïve and credulous babes in the woods or they have been colonised by lefties too.

    I lean towards the second alternative.

    The 2 alternatives are not mutually exclusive Bruce.

  16. cohenite

    I’m genuinely interested

    Well, consider this; NO green or renewable energy source exists without subsidies coming out of its backside. In short renewables make money because taxpayer money is given to them. How do you compare an energy source, fossils, which work with an energy source, renewables, which don’t.

    I’m genuinely interested in how you explain that.

  17. michaelfstanley

    Well, consider this; NO green or renewable energy source exists without subsidies coming out of its backside. In short renewables make money because taxpayer money is given to them. How do you compare an energy source, fossils, which work with an energy source, renewables, which don’t.

    I’m genuinely interested in how you explain that.

    My question to Sinc is whether he thinks you can measure how a diverse fund would perform against a similar fund sans fossil fuel stocks, and if so how you’d do it better than the Australia institute.

    If you’d like to join in feel free

  18. cohenite

    If you’d like to join in feel free

    How fucking jolly; I do believe I will. Did you not read my point about renewables being entirely sustained by subsidies. How do you measure investments when one operates on market profit and loss conditions and the other exists in taxpayer subsidised bubble?

  19. michaelfstanley

    I read your point but am not interested in discussing renewables versus fossil fuels. The question is about performance of Shares when including or excluding fossil fuel stocks. :)

  20. wreckage

    I already pointed out that you’re down an entire sector, so your portfolio structure is compromised. It has been argued that portfolio structure is the only really important factor in determining long-term performance, since it controls risk. It’s a safe bet that, long term, the divested portfolios will suffer.

    The honest way to assess would be a historical review. First, decide criteria for selection, without determining start year. Start year and start month are randomised. (End 1-20 years later on a random month.) Construct two portfolios with the same criteria. Remove fossil fuel and mining stocks from one, replacing each in turn with the next-best stock determined by the same criteria, dropping the replacement stock and replacing by the same method if it is also fossil-fuel or mining.

    Lather, rinse, repeat. Each repeat reports and compares dividends plus capital growth.

    There are some problems with this approach, but it should get you a result without too much of the “outcomes determining the experiment” problem, if that is the problem Sinc is referring too. But I’m not a statistician, so there might be another problem I’ve missed.

  21. AP

    Choice should stick to dishwashers, hair dryers and vaccuum cleaners (which incidentally are made from and consume fossil fuels). All this other stuff is waaay too complicated for them to understand.

  22. AP

    michaelfstanley: it is unknowable. google “Schrodinger’s cat”.

  23. nerblnob

    There is no such thing as a “fossil free” investment.

    Since we’re posing questions because we’re “genuinely interested”, can somebody please give me a list of “fossil fuel” companies which have been harmed or discouraged by “divestment” (which appears to mean selling your shares. Presumably to a buyer, but hey, I’m no economist) ?

    if, as I suspect , the list is small to non-existent, then this movement is pointless except as self-serving activism which will most of all harm the institutions practising this “divestment”.

  24. michaelfstanley

    Thanks Wreckage for the input

  25. wreckage

    then this movement is pointless except as self-serving activism which will most of all harm the institutions practising this “divestment”.

    I’m rather in favour of activism where the activist takes the hit, instead of forcing someone else to do so; I’d be delighted to learn it was a viable (though clearly not optimal) investment strategy in its own right. That would fit my free-market idealism perfectly; don’t like Big Hydrocarbon? Divest.

  26. michaelfstanley

    It would render you a criminal to encourage others to exercise their free choice to do so if Judith Sloan has her way…..

  27. wreckage

    Activist funds should only be entered into voluntarily. As such, no Industry Super Fund (for example) should ever be anything but optimised and as diverse as possible. So in that situation, yes, illegal. But for individual investors, or clearly designated and strictly opt-in specialty funds, no.

    The problem here is that compulsory super is very, very shaky as far as “voluntary” and “opt-in”, which IMHO is borderline unethical and needs to be addressed, but taking those funds out of their ostensible purpose (securing retirement) and then moving them into another purpose (activism) would absolutely be unethical, and should be illegal. Ideally, all super funds should be strictly opt-in, and should adhere closely to their clear, plain English, stated goals.

  28. wreckage

    If your encouragement includes statements you should know to be false, like “with no loss to long term performance”, then that should be illegal, yes, as it is in most of the commercial world, but especially in dealings with consumers.

  29. wreckage

    In fact, if Sinc is accurate regarding performance, and someone spruiked a 33% worse than usual underperformance as “no significant loss”, Choice should be all over them like a rash.

  30. JC

    It has been argued that portfolio structure is the only really important factor in determining long-term performance, since it controls risk. It’s a safe bet that, long term, the divested portfolios will suffer.

    I’ve never understood how diversification works effectively. I understand the argument in that people believe one can’t beat the index over the long term, but it goes against everything I’ve learnt as a trader.

    The proper way to diversify is to keep a balance portfolio. Lets say the split for diversification is 1/3 for each sector. When a sector goes much higher than the other two, one is supposed to sell a portion of it and reinvest the money in the less performing sector.

    So the idea is to cut profits and potentially increase losses, or rather go from a well performing sector into a weak one.

    Huh?

  31. wreckage

    I don’t think it works for a trader, JC, and I’d assume that the more active you are as a trader, the worse it works.

  32. JC

    Wreckage

    I’m applying the most basic rule taught to traders which is let profits run and cut losses. I don’t see how it’s a good strategy to rebalanc a portfolio by cutting profits and moving to potential losses or rather loser sector all in the interests of diversification.

    I think those funds are a fraud quite frankly and people get taken in by them.

    (Oh and the Australia Institute stuff is basically dishonest, willful fraud.)

  33. Crossie

    Anyone who takes financial advice from Choice deserves to be saddled with a lemon. I noticed over five years ago that they shifted left and haven’t bothered to check their recommendations since.

  34. kae

    Used to have a gift subscription to Choice.

    It got way too save the planet/AGW and I asked for the person buying the subscription to stop as it was crap. I won’t support any mob which thinks preaching green/save the planet/AGW is how I want to live my life and what I want to read.

  35. .

    JC – traders see profits. Portfolio managers and academics see risk return frontiers.

    I would like to set up my superannuation based on downside risk, but the mug investor doesn’t have this data.

  36. Rabz

    Anyone who takes financial advice from Choice deserves to be saddled with a lemon. I noticed over five years ago that they shifted left and haven’t bothered to check their recommendations since.

    I seem to remember them being quite left back in the days of Howard.

  37. .

    Choice don’t give a crap about empowering consumers.

    They want to punish producers.

  38. Pusnip

    The Australia Institute and Choice are made for each other. Paternalism and simplistic analysis, though that seems to be enough to keep their soft Left target audience happy. And of course to receive plenty of uncritical airtime on the ABC.u

  39. Blogstrop

    It’s some years since I bothered to consult choice magazine’s roundup on an appliance, and back then I got the distinct impression that low power consumption trumped all other aspects.
    Since I can read those labels for myself in the store, their assessments are surplus to requirements. It’s highly likely that a group such as Choice will end up captive to or being in fact a leftist lobby group

  40. kae

    Blogstrop

    I think choice already is captive to the left.

    I was still subscribed for over a year after I asked for my gift subscription to be cancelled.

  41. Andrew

    Wonder how a hard green-left portfolio went over that time. Find every listed Green thought bubble. Construct an equal-weight portfolio, rebalance at new IPOs. Babcock Wind, Flannerydynamics, that think that sunk into the ocean at Port Kembla, plus all their, um, success stories.

    Anyone got a list of all of them? I might even do it myself.

  42. wreckage

    Andrew: more fun: see what happens if you borrow 50% of the funds to build that portfolio in the first place.

    >:)

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