Is passive investing an impediment to ESG?

White paper argues passive managers fall short, but not everyone agrees

Is passive investing an impediment to ESG?

A new research paper is suggesting that passive funds fall flat when it comes to addressing ESG considerations.

In a white paper titled Is passive investing killing ESG?, Pangaea Wire Group Director Klisman Murati argued that active managers “have a mandate from their clients to engage with management of listed companies” to fully define and defend their ESG vision for the purpose of enhancing share value. Passive funds, on the other hand, have no duty to engage.

“Due to the lack of engagement with management, passive funds cannot shape what they consider as effective ESG policy for the companies in their fund,” Murati said, as reported by ESG Clarity.

While Murati reportedly acknowledged a number of passive funds that operate with ESG considerations, including two mandates from Vanguard, he argued in the paper that their approach of negative screening misses the true aim of responsible investing: “to build a philosophy of positive environmental, social and governance principles for all companies to engage in, and to use the voice and leverage as a shareholder to hold companies to account to these standards.”

The upshot, the report said, is that portfolio companies, if not actively held accountable by investors, “risk neglecting their ESG responsibilities or may pander to the fog of public opinion.”

Still, not everyone is buying that. Speaking to ESG Clarity, Morningstar Director of Sustainability Research Hortense Bioy cited passive managers’ “fiduciary duty to their investors to push for changes that will increase shareholder value.” Rather than denying their stewardship responsibilities, she said, “index managers are increasingly taking an active role in the oversight of investee companies,” citing BlackRock’s recent commitment to act against climate change.

On the flip side, she took aim at the assumption that active managers are always active owners of companies. Expecting every active management team to engage directly with all the member companies within their portfolios is unrealistic, especially in the case of companies with small weightings.

“Unlike active managers, index managers can’t sell poorly run companies,” Bioy argued. “They must either put up with poor governance or encourage positive change through voting and engagement.”


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