Passive investing presents a challenge for decarbonisation. Here are six projects we’re backing to help change things

The Hewlett Foundation recently awarded $2.45m to ‘climate-forward’ passive asset management. Marilyn Waite explains why.

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With thousands of fixed-income and public equity funds on the global market, retail and institutional investors face difficulty deciphering which are climate-forward at best, and not harmful to the planet at least. Efforts such as France’s SRI label help as a first filter for what may qualify, but most funds are not aligned with decarbonisation. To make matters worse, computer algorithms are taking over asset management, and the rules are programmed to track an uninhabitable world.

Over $100trn is invested through the asset management industry. In the US, 80% of employer-sponsored retirement plans are stuck in the default allocation offered; and this default is most often a passively-managed fund that directs capital to high carbon emitting projects and companies. While at least $17trn of professionally managed funds now consider ESG factors, the incorporation of climate risk and impact is not at scale. One of the culprits preventing the decarbonisation of asset management is the use of passives, where a fund’s portfolio mirrors a high-carbon market index.

The rise of passive investing is remarkable: over half of the US public equity market is now passively managed, with Asia following at 50% and Europe at 33%. Fixed income is catching up with the trend: in 2017, passive bond funds made up 30% of fixed-income assets in the US, 18% in Europe, and 10% in Asia.

Computer algorithms are taking over asset management, and the rules are programmed to track an uninhabitable world

Currently, the default market benchmark is more likely to be the MSCI ACWI Index than the MSCI Climate Paris Aligned Index. The problem is often exacerbated by outdated financial regulation, a narrow understanding of fiduciary duty, and the inertia surrounding moving assets from existing default options.

Earlier in 2020, the William and Flora Hewlett Foundation launched a Request for Proposal to fund projects with solutions to the problem that passive investing presents to decarbonisation. After receiving over 70 applications from the target markets of China, Europe and the US, we selected an initial six to receive $2.45m. The awardees represent promising interventions to align passive asset management with climate action.

In alphabetical order by firm:

1. Adasina Social Capital and Impact Experience will partner with climate impacted communities to create open-access resources for asset managers and asset owners. These resources will make data available that can guide passive investment funds to embrace more climate solutions, especially those involving climate-friendly agriculture. This project hopes to fill gaps in data about the global seed, agrochemical and synthetic fertilizer markets, while creating a sustainable agriculture investment screen that will address climate change and racial justice.

2. In a coalition effort, Americans for Financial Reform Education Fund (AFR), the Action Center on Race and the Economy Institute (ACRE), the Public Accountability Institute and Bargain for the Common Good will campaign to change the definition of fiduciary duty to include the obligation to integrate ESG factors – including climate change – in investment actions. The campaign will work at both the policy level, with AFR and ACRE leveraging their knowledge of ERISA and Department of Labor regulations, and at the community level, helping workers understand how their retirement funds are being invested.

3. Green Climate Finance Illinois, sponsored by the Climate Jobs National Resource Center, will work to implement an annual carbon disclosure impact analysis for labour union pension funds and codify an investment strategy with consultants to incorporate ESG considerations into investment decisions.

4. Partnering with various affinity investor groups, Nia Community Foundation and Nia Impact Capital will launch a series of online presentations for individual investors about the importance of moving money away from polluting passive investment funds into climate solutions-focused portfolios. These presentations will build on tailored sessions with a large network of women-focused and environmental organisations.

5. Working in the US, Europe, and China, Wilshire Associates plans to design a climate change educational curriculum in video format aimed at educating and empowering asset owners so they will be able to make better informed allocation decisions. At first working with a small group of asset owners and personally guiding them through the curriculum and building their understanding of lower-carbon index opportunities, Wilshire hopes to provide broader access to the curriculum through a dissemination partnership.

6. With the goal of helping asset managers expand and improve their offering of Paris-aligned ESG products, the World Resources Institute will develop a framework for evaluating such products and then apply that to existing offerings. WRI will then work with up to four major public and private retirement plans to encourage them to include products determined to be high quality among their default options.

We look forward to seeing how these projects can create a new path for climate solutions within asset management.

Marilyn Waite leads the climate and clean energy finance portfolio in the William and Flora Hewlett Foundation’s Environment Programme