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A trend popular at many American universities has been to divest their holding of the stock of companies in businesses related to fossil fuel production. More recently, even the church has become involved. In reaction to the papal environmental encyclical “Laudato Si,” Catholic Institutions worldwide are considering divesting fossil fuel holdings. Despite its popularity, there are three reasons to conclude that this effort is misguided.
First, from a strictly financial point of view constraining investment opportunities must have a downward impact on investment performance of any fund compared to unconstrained investment portfolios. After all, an unconstrained investor can always choose to hold a constrained portfolio, but the reverse is not true. In addition, adding constraints limits portfolio diversification which will negatively impact the risk-return tradeoff. How important this depends on how broadly the term “fossil fuel companies” is interpreted. If it means just major producers of fossil fuels, the issue can be largely ignored because they are a small fraction of the global market. However, if the term is interpreted more broadly, it leads to the second point.