Passive funds and responsible investment have been two of the key themes in asset management over the last 10 years.

The growth in passive funds has been driven by a combination of factors related to costs, evidence on the relative benefits of active versus passive investing, and new financial products such as exchange-traded funds. Increasing evidence of correlation between the ESG incorporation and enhanced risk-adjusted returns, a desire to reflect investor values in investment strategies and increasing availability of ESG data have encouraged the growing interest in responsible investment.

These trends have come together to drive a proliferation of ESG indexes and the growth in assets managed using passive ESG strategies. As with any developing market, the growth of ESG in passive investing has faced and is facing challenges.

This discussion paper looks to identify some of the issues associated with the development of this market and, as part of a consultation process, to gather feedback and ideas from signatories and other stakeholders for further guidance from the PRI on the incorporation of ESG issues in passive rule-based investments.

As an introduction to the subject, this paper includes an overview of the ESG and passive market landscape, before discussing some key challenges associated with ESG in passive investments, specifically looking at: 

  1. ESG incorporation – PRI Principle 1
    Issues include availability and consistency of corporate data, consistency of ESG scores, complexity and transparency of benchmarks and indices, unintended portfolio skews and costs.
  2. Active ownership – PRI Principle 2
    Issues include free-riding, familiarity with holdings, resourcing, contribution to overall portfolio performance, divestment, proxy voting regulations, stock lending and acting in concert.

How can a passive investor be a responsible investor? (PDF)

Discussion points

This paper does not outline a PRI view or represents the views of our signatories but will be the first step in the process of collating a range of views to develop further guidance for asset owners, asset managers and other service providers. The PRI is looking to gather signatory feedback on 12 questions, covering four topics:

  • Market overview;
  • Identifying the challenges;
  • Creating solutions; and 
  • Active ownership

The responses to these questions will help the PRI develop further guidance on the development of ESG factors into passive rule-based investments. We look forward to input from signatories and other interested parties. We welcome feedback and queries to [email protected] and a invite you to join a newly created collaboration platform.  

Survey: Challenges and solutions for ESG in passive investment