Carbon Bias in Index Investing

23 Pages Posted: 28 Jan 2022

See all articles by Mathijs Cosemans

Mathijs Cosemans

Erasmus University - Rotterdam School of Management

Dirk Schoenmaker

Rotterdam School of Management, Erasmus University; Erasmus Research Institute of Management (ERIM); Centre for Economic Policy Research (CEPR)

Date Written: January 23, 2022

Abstract

This paper presents evidence of a bias towards carbon-intensive companies in popular value-weighted stock market indices that are tracked by index funds and ETFs and serve as benchmark for active equity strategies. The average carbon bias in the U.S. Russell 1000 is close to 70% and the bias in the MSCI Europe index is about 90%. This means that the carbon intensity of the U.S. and European market indices is 70% and 90% higher than that of the U.S. and European economy, respectively. The carbon bias arises because firms operating in carbon-intensive sectors, such as mining, manufacturing, and electricity, tend to be more capital intensive and more likely to be publicly listed. These companies therefore issue more equity than firms in low-carbon sectors and receive a larger weight in the value-weighted stock market index than in the real economy. The carbon bias is problematic because it exposes institutional investors such as pension funds to carbon-transition risks and is at odds with their drive towards sustainability. We therefore explore several strategies for investors to mitigate the carbon bias in their equity allocation.

Keywords: carbon emissions, climate change, climate finance, institutional investors, index investing

JEL Classification: G11, G23, D62

Suggested Citation

Cosemans, Mathijs and Schoenmaker, Dirk, Carbon Bias in Index Investing (January 23, 2022). Available at SSRN: https://ssrn.com/abstract=4016221 or http://dx.doi.org/10.2139/ssrn.4016221

Mathijs Cosemans (Contact Author)

Erasmus University - Rotterdam School of Management ( email )

Burgemeester Oudlaan 50
Rotterdam
Netherlands
+31104082371 (Phone)
+31104089017 (Fax)

HOME PAGE: http://www.mathijscosemans.com

Dirk Schoenmaker

Rotterdam School of Management, Erasmus University ( email )

P.O. Box 1738
Room T08-21
3000 DR Rotterdam
Netherlands

HOME PAGE: http://www.rsm.nl/people/dirk-schoenmaker/

Erasmus Research Institute of Management (ERIM) ( email )

P.O. Box 1738
3000 DR Rotterdam
Netherlands

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
271
Abstract Views
1,127
Rank
171,349
PlumX Metrics