Climate-change ETFs: dead weight in the battle against global warming?

Academic research suggests greenwashed funds steal capital away from sectors that are leading the clean-economy transition

Climate-change ETFs: dead weight in the battle against global warming?

Touted as vehicles for investors to do good while doing well, climate-focused investment funds are actually sabotaging the war against global warming by regularly engaging in greenwashing, according to academic research.

Passive ETFs that track indexes with labels such as “low carbon,” “climate change,” or “Paris aligned” apportion little of their money to the greenest companies and routinely give more room in their portfolios to companies with declining environmental performance, according to a study cited by the Financial Times.

The study, titled Doing Good or Feeling Good? Detecting Greenwashing in Climate Investing, was produced by Edhec, a French business school and think tank.

Analyzing Europe-listed ETFs from managers including Amundi, BNP Paribas, BlackRock, and HSBC with underlying indices from MSCI, FTSE Russell, and S&P Dow Jones, Edhec found 35% of constituent companies with worsening environmental performance are given increased weighting within the funds. The figure rises to 41% of stocks with deteriorating carbon intensity, which is measured by emissions per unit of output.

An unfortunate upshot, the paper said, is that the ETFs effectively suck up capital that could and should have gone to sectors that are playing a central role in the transition to a cleaner economy.

“Since considerable investment is necessary to ensure electrification of the economy and decarbonisation of electricity, underfunding of this sector in climate-aligned benchmarks … would constitute the most dangerous form of portfolio greenwashing,” Felix Goltz, co-author of the paper, told the Financial Times.

According to Goltz, the divergence between the climate performance and the portfolio weightings of the companies held by climate ETFs takes away the credibility of the efforts that the investing companies undertake to engage those companies to improve their ESG practices.

The inconsistency between investment and ESG performance, he argued to the Times, stems from climate funds’ fixation on absolute climate performance scores, while overlooking ESG momentum. Because the constituent companies are not penalized as long as do not trip a defined lower bound in ESG scoring, their performance can theoretically drift downward to a certain degree without consequence.

“Climate strategies, just like business-as-usual strategies, are mostly influenced by the market capitalisation of stocks. The climate score plays second fiddle at best,” Goltz said. “This demonstrates the dominance that these indices have in the investment management industry.”