IEEFA – Passive Investing in a Warming World, February 2024

The report by IEEFA discusses the changing perception of fossil fuel companies as blue-chip holdings and the impact on broad-market equity indices. Historically, fossil fuel companies were seen as reliable investments with steady growth. However, disruptions in commodity markets, competition from renewable energy, and growing concern over climate change have led investors to reconsider the energy sector's role in their portfolios. The report highlights the underperformance of the energy sector compared to flagship equity indices like the S&P 500 over the past decade. In eight of the ten years between 2012 and 2021, the energy sector performed worse than the S&P 500, and in five of those years, it was the worst-performing sector. This decline in performance has led to a decline in the market capitalization of the fossil fuel sector relative to other sectors in the stock market. At the same time, there has been a significant increase in the popularity of passively managed investment funds that track market indexes. These funds have seen significant inflows since the Great Recession. Additionally, major index providers have launched new equity market indices that exclude or underweight fossil fuel companies. These indices have gained the attention of investors and have been tracked by index funds. After a period of underperformance, the fossil fuel sector experienced a strong rebound in 2021 and 2022, driven by the world's recovery from the COVID-19 pandemic. However, the long-term outlook for the sector remains uncertain given the ongoing shifts in the energy market and investor sentiment towards climate change risks.