(Bloomberg) -- As Vladimir Putin amassed military forces on Ukraine’s borders in January, Vanguard Group and Northern Trust Corp. increased their holdings in Russia’s leading bank via some unlikely portfolios: their ESG funds, which invest with a mandate to minimize “environmental, social and governance” risks.

Big asset managers, including Blackrock Inc., State Street Corp. and Amundi SA, also hold shares via ESG funds in Sberbank PJSC, and in Russian oil companies Gazprom PJSC and Rosneft PJSC, according to data compiled by Bloomberg. In total, ESG funds held at least $8.3 billion in Russian assets before Putin invaded Ukraine.

The Northern Trust and Vanguard portfolios, which meet the official European standards for a sustainability label, are index funds, and the uptick in Sberbank holdings was probably tied to a rebalancing of stocks in the index or distribution of new money, not an active choice based on the company’s fundamentals. But the timing, just weeks before Russia’s invasion of Ukraine, and now the challenges of dumping Russian stocks point to one of the challenges of passive investing for ESG investors.

“Passive investing and sustainable investing aren’t good bedfellows,” said Jack Nelson, portfolio manager at Stewart Investors’ Sustainable Funds Group. “If you’re investing in an active fund, you can make a judgment. If you’re doing it passively, you’re switching into a robot.”

Vanguard declined to comment on individual holdings, saying in an online statement that it’s actively working to exit its positions in Russian companies, most of which are held in index funds. Northern Trust said it’s taking steps to appropriately manage its clients’ “very limited” exposure to Russian securities, which is primarily through index funds, and will “liquidate positions that no longer meet account objectives or aren’t compliant with applicable sanctions as soon as practicable.” 

Once limited to broad market portfolios like the S&P 500, the explosion of niche index products has made it possible -- and cost-effective -- for ESG investors to adopt the same strategy. ESG indexes provided by firms like FTSE Russell and MSCI Inc., and the funds that track them, favor companies with high ESG ratings, underweight those that score poorly, and screen for additional problem sectors such as weapons, coal and tobacco. 

This means that even stocks with traditionally low ESG credentials, such as fossil-fuel companies or autocratic state-owned banks, find their way into ESG-labeled funds. As the fund grows, or the poorly rated companies do, those positions increase. 

But outsourcing decisions around what constitutes a sustainable investment lets asset managers avoid responsibility for sometimes questionable holdings, said Adrienne Buller, senior research fellow at Common Wealth, a UK-based think tank. 

“Index funds are a get-out-of-jail-free card for having these kinds of holdings,” she said. “There’s the ability to point the finger at [the index provider] who can then point it back at the asset manager and say that, well, legally they don’t have to exactly abide by everything that we have in the basket.”

Last Wednesday, MSCI and FTSE Russell announced they are cutting Russian equities from their widely-tracked indexes, excluding them from large swathes of the investing world. BlackRock said last Thursday that it had halted purchases of Russian securities across its active and index funds. 

Those who are now trying to unload their Russia positions are having a hard time. The Moscow Stock Exchange has been closed since Feb. 28 and hasn’t said when it will reopen.

Sustainable funds, including ESG offerings, collectively oversee about $2.7 trillion worth of assets. But as the broad category has grown in its appeal, the industry has come under fire for failing to match its rhetoric with changes in the real economy, and remains divided on its purpose and methods. The death toll in Ukraine has surfaced those divisions again and with new urgency.

“These unprecedented events are a real live stress test for portfolios, for investors and for index providers,” said Dimitris Melas, head of index research at MSCI. “In the end, it took us just a couple of days to react.”

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