Passive boom could slow fossil fuel withdrawal, think tank warns

Estimates of the total assets invested passively worldwide — comprising exchange traded funds and traditional index-tracking mutual funds — now sit beyond $15tn (£11.5tn), the think tank said.

UK pension funds are participating in the swing from active to passive investing, with an increasing interest in the green credentials of these assets. 

In April, the circa £10bn Northern Ireland Local Government Officers’ Superannuation Committee transferred its £2.8bn core passive equity holdings into Legal & General Investment Management’s Low Carbon Transition Fund.

Passive funds may, however, play a role in slowing down the UK’s carbon transition, Common Wealth warned.

The think tank said that index providers “play an outsize role” in ESG investment.

“Many, such as MSCI, double as prominent ESG ratings agencies, providing scores for companies based on criteria such as carbon footprinting or the make-up of a company’s board,” it stated. 

“A critical issue here is the extent to which a handful of index-providing houses have effective control over the definitions of ‘sustainable’ or ‘green’, with little regulatory scrutiny.

“As it stands, there is no regulation of these ratings. Consequently, they are often based on criteria and discretionary judgments that differ wildly between providers.”

Common Wealth acknowledged a convergence between passive and active ownership, as the rate of passive fund growth outpaces that of the active industry. 

This is most evident for fossil fuels, with the sector being the only major sector for which passive funds constitute more than 40 per cent of fund ownership.

“Passive funds are uniquely overrepresented in their ownership of the oil and gas industry, lending support to the idea that these funds are on track to becoming ‘holders of last resort’ in carbon intensive sectors,” it warned. 

“Observers have raised concerns that by yielding their discretion over investment decisions, the rise of the passive investing industry will create inertia in moving capital out of carbon-intensive sectors, making these funds the ‘holders of last resort’.”