The Limitations of Passive Investing to Achieve a Net-Zero Outcome

In our second installment of The Fine Print of Indexation, we tackle the challenge of building net-zero-aligned portfolios.

It may be tempting simply to track or refer to one of the climate benchmarks currently available or being developed by index providers and climate data vendors. Yet for all convenience that climate index funds ostensibly afford, we believe the indices they track come with a number of flaws—from incomplete data to subjective construction methodologies—that can lead to undesired outcomes for investors.

This paper continues our closer examination of the potential limitations of passive equity investing. Our first installment, The Fine Print of Indexation, highlighted how index providers tweak the construction of their benchmarks to enhance liquidity; we argued that, while these maneuvers helped index fund managers accommodate massive asset flows, they also potentially crimped investors’ returns.

In this second installment, we show how passive investing to achieve a net-zero outcome invites its own set of challenges. At this early stage of net-zero adoption, and in light of climate-indexation’s potential limitations, we believe investors are better served taking a more nuanced and active approach to achieving their specific climate-investing goals.