Today, Business Forward Foundation released a report on the influence index funds have on fossil fuels companies and climate risk, in general. The Downside of Index Funds explains how buying the market “as it is” props up coal, oil, and gas companies active managers have been avoiding.

For years, Wall Street’s biggest asset managers have advised their high net worth clients to get out of fossil fuels, and clients who listened avoided heavy losses in coal, oil, and gas. Earlier this year, BlackRock, the world’s largest asset manager, surprised the markets by declaring that sustainability “should be our standard for investing.”

Because sustainable investment options have the potential to offer clients better outcomes, we are making sustainability integral to the way BlackRock manages risk, constructs portfolios, designs products, and engages with companies. 

Index funds operate differently. They are “passive,” which means they buy the market as it is, no matter what the experts say about where the market’s heading. Economists call this the “index effect,” and it is propping up coal companies at the expense of renewable energy and other investments. Index funds managed by BlackRock are twice as “thermal coal intensive” as BlackRock’s active funds. The result? Losses in coal, oil, and gas are carried disproportionately by small investors. More than half of the U.S.’s assets are in passive funds, and the asset managers investing those funds will not switch to sustainable alternatives, unless their customers make them.

This difference has systematic implications: fossil fuel companies raise more capital than they otherwise would, and they use about one-third of it to bring new fields online, which accelerates the climate crisis. Index funds offer small investors lower fees, lower risk, and more diversification, but we need ESG reforms to fix this market failure: Small investors — and our planet — deserve it.