DiBartolomeo, Dan. "A View of Tobacco Divestiture by CalSTRS." Working Paper, Northfield Information Services, April 2000.
Reviews the investment implications of tobacco divestiture in five areas - past performance (index level), potential future returns (index level), past risk and return, tracking error, and transaction costs.
Past Performance: "One dollar invested in tobacco stocks at the beginning of 1989 would be worth $4.84, while the same dollar invested in the broad S&P 500 would now be worth $7.01," although the authors note that the tobacco index reached a peak value of $9 in late 1998.
Possible Future Performance: Uses Bayes-Stein analysis to forecast future returns from past patterns - "when we applied these statistical techniques, the difference in the annual arithmetic returns shrank from the 3.19% in favor of the S&P 500...to just 16 basis points. Also sums analysts' growth estimates and adds dividend yield to obtain an alternate estimate of 18.27%, 2.22% greater than for the S&P 500.
Past Risk and Return: Backtested the S&P 500 for the 1989-1999 time period vs. a tobacco-free S&P 500 portfolio. Returns and risk for the two portfolios were virtually identical.
Tracking Error: Tracking error in the backtest was 42 basis points per annum. The authors argue that this is not material, given that the discrepancy is not as large as between the S&P500 and other broad market indexes from Russell and Wilshire.
Concludes that "there is no compelling reason to believe that the divestiture of tobacco stocks would have any negative impact on the future investment performance of CalSTRS."