Climate-focused investors should consider paying a separate fee to their index fund managers to cover the cost of engaging with underlying companies, the Institutional Investor Group on Climate Change (IIGCC) has said.
In a new report exploring the challenges of integrating the climate transition into index-based strategies, IIGCC observed “engagement tools remain limited”.
The use of index funds and exchange traded funds (ETFs) continues to rise, and was estimated to account for 43.5% of global long-term assets in 2024.
“For the first time, asset owners are implementing sustainable investment more often through index strategy implementation than through active strategies,” said the report, adding that the growing concentration of ownership amongst the biggest index managers “raises questions about whether they exercise too much or too little influence over the companies in which they invest”.
The working group behind IIGCC’s latest paper includes experts from The People’s Pension, Phoenix Group, Aberdeen Investments, AP7, GIB Asset Management, HSBC Asset Management, IFM Investors, Ilmarinen, Legal & General, LGPS Central, Russell Investments, and Velliv.
They identify a number of possible solutions for asset owners seeking to encourage their portfolio companies to decarbonise in line with the goals of the Paris Agreement.
“In the case of index funds, asset management fees are often too low to support meaningful engagement across large, diversified portfolios, even when asset managers apply a targeted approach,” it argued.
It called for a “sharper focus” on the topics, sectors and companies with the greatest potential for impact, recommending the adoption of in-house active ownership strategies.
“Another approach is to allow index fund managers to charge stewardship costs directly to the fund and pay asset managers a separate fee for engaging portfolio companies,” said IIGCC.
“This ensures that investors benefiting from engagement also share in the costs.”
Given the lack of understanding of what resources are already being channelled into stewardship and engagement activities, the report advises asset owners to start by getting clarity on current resourcing levels before considering paying more.
The paper also highlighted challenges around the lack of visibility as to how index providers consider climate issues, and concerns about the tracking error associated with climate indices.
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