If we could use a time machine, go back to January 1st, 2015 and invest in our climate friendly portfolio, how would it have performed?
You may have seen our analysis of the stock portion of Carbon Collective portfolios against standard benchmarks such as the S&P 500 and the Russell 3000. On this page, we show the same simulation but for three diversified Carbon Collective portfolios (stocks + bonds + cash).
We built Carbon Collective’s stock collection to track the total stock market, like an index fund, but replace the high-carbon companies with those building solutions to climate change.
In Carbon Collective’s bond portfolio, we replace generic bonds with green bond that support the construction in renewable infrastructure. These are balanced with a collection of US treasury bonds to provide adequate diversification.
You can read more about our methodology for building our climate-friendly investment portfolios and checkout a full breakdown of our portfolios allocations.
Carbon Collective’s climate friendly portfolio hasn’t existed until now, so the only way for us to evaluate its financial performance is to run a simulation.
In our case, we asked ourselves, “what if we had launched the Carbon Collective investment strategy, not today, but on the eve of 2015?”
Before diving in, let’s go through a quick overview of how we build our stock portfolios.
The stock market is constructed of 11 sectors (technology, utilities, real estate, etc.) At a high level, our portfolios directly invest in index funds that track the seven low-carbon sectors of the stock market (~80% of the market in 2020). They give the allocation that was going to the high carbon sectors (~20%) to our collection of companies building climate solutions. Our goal is to use market sectors to track the market like an index fund, but replace the high carbon sectors with the companies building climate solutions.
Ok, back to the math. From here on it’s pretty technical.
We begin the simulation with data pulled from 12/31/14 and update the sector allocations annually on the last day of each year through 12/31/19. This better simulates how this strategy would have actually performed by incorporating the historical market capitalization of each sector and rebalancing the portfolio’s stock allocations annually based upon it. For example, on 12/31/14, the stocks representing the energy sector made up 8.45% of the total value of the stock market. By 12/31/19, where we simulated the last annual rebalance, energy stocks represented only 4.35% of the total stock market.
Things got a little more complicated for the individual stocks. Unlike the seven low-carbon sectors which we represent with individual sector ETFs, the remaining four sectors are populated with stocks from the individual companies building climate solutions. Here’s an example of how we calculated the allocations for an individual stock in our Drawdown Index:
Question – Why didn’t we simulate further back to say, 10 years?
Answer – Too few of the companies in our Drawdown Index had yet entered the stock market 10 years ago, so we found simulating further back deviated too far from our strategy.
Further notes (if you want to double-check our math):
Overall, while this exercise represents our best attempt at honestly simulating “what would have happened” if we had launched this strategy on 12/31/14, it is far from comprehensive. We sought to err on the conservative side, only rebalancing the portfolios annually with the new market sector weightings. In reality, our portfolios rebalance more often than that, using a trigger to buy or sell holdings in a given sector should it grow or shrink by more than 25% of its initial weightings within the year. Such rebalancing tends to perform better over time (at least historically). Historical results are no guarantee of future returns.
Betterment provides a calculator that allows you to see how their standard portfolios performed over a given time period. At the time we sourced this data, Betterment provided their historical data through June 30th, 2020, so we used this as the final date for all of the portfolios in this calculator and looked at the time period stretching back five, three, and one year from it. All data we provide in our comparison was directly copied from Betterment’s calculator.
Question: why are Betterment’s returns so much lower than Carbon Collective’s or either of the Vanguard Index portfolios?
Answer: We cannot be fully sure. Betterment has not published their fund allocations, so what follows is speculation. The most likely culprit is that many robo-investors like Betterment hold a high percentage of their equities in international funds. Over the past five years the international stock market has not performed as well as the US stock market.
We do not include international funds in our portfolio because we could not find one that did not include fossil fuel companies and met our financial criteria for investment. Are international equities necessary in a diversified portfolio? Our answer (and Jack Bogle’s – Vanguard’s founder) is no international equities are not necessary in a balanced portfolio.
On the calculator showing historical returns on the product page, one of the categories is Vanguard Index Portfolio US Only. These represent three simple portfolios built with Vanguard’s broad market ETFs.
These portfolios do not include any international holdings, making them a better “apples to apples” comparison with Carbon Collective’s portfolios. It’s for this reason that we decided to include them on the main page calculator. They are still not a perfect comparison as Carbon Collective’s portfolios do have some international bonds through the two green bond funds.
For further context, we also compared Carbon Collective’s portfolios to a series of Vanguard index portfolios that did include international holdings. While we derived the allocations for these from a 3rd party source, they closely align to the same stock, bond split:
We pulled results from the simulation from three sets of time periods:
The financial statistics below are from the “5 year” time period spanning 06/30/15 – 06/30/20:
If you would like some further reading into the high-level allocations, comparison of risk and returns, and a breakdown of each holdings performance, check out the series full PDF below: