Why have passive ESG indices been criticized as being more active than they are presented?

The criticism of passive ESG indices as being more active than they claim largely stems from the opaque methodology and construction process of these indices, which can involve human judgment and bias. This suggests that the selection criteria are not entirely objective, leading to discretionary elements in the index composition.

Unlike traditional passive indices, which are typically based on clear, rule-based methodologies, ESG indices might incorporate varying interpretations of what constitutes an acceptable ESG score. As a result, the judgments made by index creators can reflect biases or subjective views about sustainability and ethical considerations. This subjectivity can result in significant deviations from pure passive investing principles, making them behave more like actively managed funds where decisions are influenced by fund managers’ perspectives.

Understanding this aspect is critical for investors who may assume that passive ESG indices function purely on established, non-subjective criteria akin to traditional passive indices, when in fact the complexity and variability in the criteria applied can lead to a level of active management behavior. Hence, it highlights an important nuance in the assessment of ESG investment products.