Index Funds Are Climate Change Denial
You probably know that index funds have become all the rage in investing over the past several years, as investors flock to their low fees and reject the gospel of active management. But you probably don’t know that investing in a broad-based index fund not only ignores rapid changes in the energy economy, but it makes the investor complicit in climate change denial. And just as climate denial ignores the inherent risks of fossil fuels to environment, economy and society, “set it and forget it” index investing ignores the inherent risks of fossil fuels and related stocks to your portfolio.
Current conventional wisdom holds that the best and most sensible way to invest in stocks is to buy a broad-market index fund with the lowest fee you can find, and then forget it. More than that, we are conditioned to judge every fund by its performance’s adherence to an index; even non-index funds are routinely judged by how closely they mirror the returns of a major benchmark. The terms “risk profile” and “risk adjusted returns” of a fund usually mean nothing more than a measure of how much (less or more) a fund’s performance varied from a benchmark index. But I would argue that, given the massive risks embedded in the present holdings of indices like the S&P 500, these benchmarks have outlived their usefulness as measures of investment risk, and now present far more portfolio danger than we are led to believe. In short, our yardstick for measuring risk is broken.
What both Stern and Morgan Stanley understand is that the world has changed and our approaches to investment need to change with it.
- Costs of renewable technologies , while fossil fuels remain volatile commodities.
- Consumers, , investors are shifting.
- Policies instituted by national governments (led thus far by and ) and local governments (the U.S. state of , and others).
The decline of fossil fuels will impact investments as much as it will impact any aspect of the economy. The S&P 500 as it’s now constituted is too packed with fossil fuels and other sources of systemic risk to represent any kind of credible reference for calculating safety of returns or expecting to earn them. In terms of the outcomes it promotes, S&P 500 is functionally the same as climate denial. It is time for a new standard.
How do we realize this new standard? We need to recognize that avoiding indexing isn’t just about putting your money where carbon isn’t; it’s now about putting your money where the future is. Think, as an investor, about the outcomes of economic and technological innovation, combined with awareness of the risks of climate change. Where is investment money flowing in response to rapid changes in both? I believe some of the answers include renewable energies, water, sustainable farming practices, efficient transportation, connected cities and grids, AI and machine learning, robotics, biotech and new approaches to real estate—to name a few.
It is in seeing the world for what it has become, rather than what it was, that investors and markets will allocate capital to manage risks and profit from new opportunities. All of which leads in the opposite direction from fossil fuels.
Enough with the old indices. We should be buying what’s next instead.