Index investing for the net zero transition

This paper is for index investors, including asset owners, asset managers and index providers, as well as policymakers, who are looking to align their investment strategies, product offerings, and policies with the Net Zero Investment Framework (NZIF 2.0) and goals of the Paris Agreement.

'Index investing for the net zero transition' paper provides practical considerations on overcoming challenges and implementing solutions that support real-economy decarbonisation through index investing.

The paper is supported by two investor case studies. One outlines how Ilmarinen, Finland’s leading pension insurer, has shifted most of its performance benchmarks to MSCI Climate Action indices and invested in ETFs in the same index to steer aggregate portfolio exposures to climate considerate allocation.  

The second explains how Phoenix Group, the UK’s largest long-term savings and retirement business, has designed and implemented the FTSE All-Share Phoenix Group Climate Index to support its decarbonisation targets and inform a sustainable default investment proposition for its clients. 

Indispensable tools

The term ‘index investing’ is often used interchangeably with ‘passive investing’. However, index investing more accurately reflects the growing sophistication of quantitative systematic strategies that seek to track the performance of a specified index. This can be achieved through mutual funds, segregated mandates such as index funds, and exchange-traded funds (ETFs).

Index funds and ETFs have become indispensable tools for institutional investors, offering cost-efficient, transparent, and scalable solutions to meet long-term financial and sustainability objectives in a rapidly shifting global market. Yet, despite their growing prevalence, index investors face significant hurdles in aligning their broad-based portfolios with net-zero targets.

Recognising the challenge, IIGCC’s Enhancing the Quality of Net Zero Benchmarks (2023) set out key principles for constructing, maintaining, and reporting on net-zero-aligned benchmarks. Achieving real-economy decarbonisation requires more than reducing portfolio emissions: asset selection, stewardship, engagement, and advocacy for systemic change are key levers for financing reduced emissions and alignment with NZIF.

Since then, IIGCC’s Index Investing working group has focused on equipping index investors with tools to support the development of their individual strategies. This discussion paper seeks to:

• Define levers of influence available to index investors and illustrate how their broad market exposure and long-term capital allocation positions them as important enablers to scale climate transition. 
• Review existing practices on index portfolio alignment with NZIF.
• Explore the potential of engagement and active ownership as an important element for any index investor striving to align with a net zero objective and manage systemic risks.
• Propose actionable recommendations for index providers, asset managers, and policymakers that could help to improve transparency and facilitate a greater shift toward index strategies integrating climate considerations.