An index fund – also known as passive investing – is a type of mutual fund that tracks a particular market index; for example the S&P 500, or FTSE. Index funds can track the whole or part of an index. About 50 percent of funds in the U.S. and Asia are now invested in index funds, and this percentage is growing globally.
One major problem with this is that as active investment exits the fossil fuel industry, passive investors are becoming the holders or last resort in stranded assets.
Three companies — Standards and Poor’s, MSCI, and FTSE Russell — accounted in 2017 for some of the 78 percent of the US$2.7 billion in index industry revenues. In other words, these three companies create the indexes and sell them on to big asset managers: particularly, in the U.S., to Blackstone, Vanguard, and State Street.
Passive investing is rearranging power in the financial system – from asset owners to asset managers. The average asset owner is now so small — relative to the total assets under management of the largest asset managers — that they may have little control over allocation strategies. Some asset owners wanting to move out of fossil fuels are increasingly frustrated by a lack of action from their asset managers.
If your asset manager makes the case that they cannot screen out fossil fuel companies in the index-tracking funds they sell, tell them they’re wrong. Both index rules and the acceptance of tracking errors – which are deviations from the performance of the fund being tracked — allow for funds to make small to moderate deviations from indices. Increasingly, index investors are switching both indices and index providers; such changes provide investors with the opportunity to exclude specific stocks.
And several studies demonstrate that tracking errors from screening fossil fuels range between about 1-3 per cent, with similar and sometimes superior returns (as you would expect given the dismal performance of fossil fuel companies recently). So if your asset manager says they can’t change, refer them to this Sunrise Project research, and tell them it’s their job to research this area properly.