The think tank Common Wealth has warned that passive funds face becoming the “holders of last resort” in carbon intensive sectors, given their growing ownership in the fossil fuel sector.
Common Wealth’s latest report published recently, The Passive Revolution, revealed passive funds now represent over 40% of all fund ownership in the fossil fuel sector, defined as oil, gas, coal extraction and related operations, as active funds have begun reducing their investments in the sector.
The findings raise concerns that the trend may hinder the UK’s climate transition on the basis that while active investors divest from fossil fuel-related companies, “less scrupulous” investors take their place.
The authors of the Common Wealth report, Adrienne Buller and Chris Hayes, said the research corroborates activist concerns that passive funds are “extending the lives of fossil fuel firms by helping sustain a higher share price and lower cost of capital despite active market moves out of the sector”.
These include private equity firms whose incentives for responsible stewardship and decarbonisation can be weaker.
On a wider scale, Common Wealth found that the overall gap between passive fund strategies and traditional active management strategies has been closing rapidly since 2010.
Research found active and passive fund ownership across different industries is converging as passive fund growth significantly outpaces the active industry.
The report further warned that although index providers have significant influence over where capital is allocated in the global economy, they remain “comparatively under-scrutinised and, critically, under-regulated”.
The think tank found that just three index firms – MSCI, S&P Dow Jones and FTSE Russell – dominate the index business and take in more than three-quarters of all industry revenue.
The report stated: “Policymakers urgently need to turn their attention to how we can create a financial system that delivers benefits to people beyond the narrow sliver of those with financial wealth, and which can escape the logic of both ecological and financial extraction that has characterised corporate governance until now.”
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