Three Boring Words and Why They Matter to Your Retirement
Indexes, Benchmarks, and Tracking Error
When you hear the words index, benchmark, or tracking error, your eyes might glaze over—and we don't blame you. These aren't exactly thrilling conversation starters. But if you care about your pension (and you should), these three concepts quietly shape whether your retirement will be well-funded or at risk from poor planning and unmanaged climate risk.
So let's break it down.
Index: The Market's Measuring Stick
An index is like a big market menu. It's a list of companies or assets meant to represent a slice of the market, mimicking the makeup of benchmarks like the S&P 500, which tracks the 500 largest U.S. companies.
Pension funds often direct investments by tracking an index. This keeps costs down and spreads risk across many companies. But here's the catch: most traditional indexes don't consider environmental or social impact. That means if high-emitting companies make up a big slice of the index, your retirement dollars could be funding climate pollution, even if your fund has a climate policy.
Benchmark: The Goalpost for Performance
A benchmark is what a fund compares itself against to see how it's doing. It's the standard. If your fund says, "We earned 8% this year," that only means something if you know what they were comparing themselves to.
The problem? If the benchmark is based on a carbon-heavy or outdated index, then even great performance may not mean progress. Pension funds need benchmarks that align with their climate goals and mission, not ones that lock them into business-as-usual.
Tracking Error: The Excuse Not to Change
Here's where it gets tricky. Tracking error measures how much a fund's performance deviates from its benchmark. A high tracking error means a fund is allowed to take more risk to outperform and possibly deviate from its benchmark.
But a low tracking error isn't always good news. It can mean a fund is clinging to the same polluting investments to stay close to the index, defeating the purpose of having climate commitments in the first place.
If the primary focus is on minimizing deviation from a benchmark, there might be less incentive for investment teams to explore new investment ideas, asset classes, or strategies that could potentially offer higher returns but would also likely increase tracking error.
Why This Matters to Your Retirement
Public pensions are built for the long haul. That means they must prudently evaluate risk metrics and long-term risks, like climate-related financial losses, and invest in a sustainable future. But if the tools they use (indexes, benchmarks, and tracking error) are stuck in the past, they can quietly undermine all that good intention.
You deserve to know:
What indexes is your fund using?
Does the benchmark match the fund's climate goals?
Is tracking error being used as a shield against managing the risk of climate change?
Understanding these terms helps stakeholders ask better questions, push for better policies, and protect the retirement future they've earned.
These three "boring" words can shape whether your pension is part of the climate solution or stuck funding the problem.
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