Index funds and the investors who own them face an unmanageable risk from climate change, according to the director of Stanford University’s Sustainable Finance Initiative. Many of those investors are pensions.

Alicia Seiger told members of the U.S. House Financial Services Committee last week that index investors are less able to manage climate risk because they’re less able to monitor it.

“Recently I worked with the $210 billion New York state pension plan to help the fund better prepare for climate-related risks and opportunities,” Seiger said. “Their investment team has taken many leading steps to address climate impacts on their portfolio already, and yet a lack of transparency into the climate-related impacts of their equity portfolio—which is largely composed of passively managed index funds—remains an unmanageable risk.”

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“Like most large pensions, to limit costs, NYCRF is heavily invested in passive index funds. In other words, they own the market, along with any mispriced risk or systemic failure.”

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Seiger cited the sudden bankruptcy of Pacific Gas & Electric Company as an example of such a failure. On paper, PG&E might have looked like a good buy for savvy investors. It outperformed other utilities in Environment, Social and Governance (ESG) assessments.

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Few PG&E investors had done the research to prepare for that, Seiger said, but index investors had no way to prepare.

“Passive index investors had no warning, and even few active investors tracked the foreseeable consequences of California’s devastating wildfires on the utility’s share price.”

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In her written testimony, Seiger urges mandatory climate related financial disclosure and a “comprehensive, science-based climate policy” which, she says, is needed to make the disclosure useful.

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