Money going into ESG funds soars but there are ongoing debates around what is included in such products
by Brian Gorman
Investors are paying nearly the same prices in environmental, social, and governance (ESG) funds as non-ESG funds, but some commentators say the distinction between the groups of funds is also becoming blurred.
Rising prices
ESG-labelled equity funds, with an average fee of 0.78%, are still cheaper than non-ESG funds with an average fee of 0.80%, according to an article in Investment Week by Elliot Gulliver-Needham, who cites research by Fitz Partners.
Fitz’s study was based on more than 4,000 products in Europe, covering US$500bn in assets, writes Gulliver-Needham, who notes that “ESG-labelled bond funds saw an average fee of 0.50%, compared with 0.53% for non-ESG bond funds”.
The closing gap was “largely attributable to the rising cost of ESG products”, writes Gulliver-Needham. The cost of ESG equity and bond funds rose by 0.02 and 0.04 percentage points respectively.
When isolating ESG funds that existed in 2022 but were not labelled as such at the time, having since been repositioned, “the study found that these were a major factor in the rising fees,” says Gulliver-Needham. “New ESG equity and bond funds presented average fees of 0.80% and 0.55%.”
Launches of ESG-labelled funds have “have kept management fees lower on average than non-ESG fund products in Europe,” says Hugues Gillibert, chief executive of Fitz, quoted in the article. "In the past year, a fair share of the increase in ESG-labelled funds has come from the repositioning of existing funds as ESG products. Unlike new fund launches, these funds new to the ESG universe have not altered their pricing while transitioning to ESG and have inflated the overall ESG funds costs."
The hidden cost in ESG funds
ESG funds may be more expensive than they look, says Jason Spiess, who cites a Harvard research study, in an article on Shale Directories.
The study says that, on average, ESG funds have 68% of their assets invested in the same assets as non-ESG funds. “The reason for this is that ESG funds are nowhere near as pure as they look to be,” says Spiess.
He quotes finance professor Malcolm Baker, one of the authors of the study. Baker makes the point that “although only about a third of your money in the average ESG fund is distinctly green, you incur the fees on the entire portfolio”. So, in essence, you’re paying three times as much for the thing you care about, the differentiated piece of the portfolio, he says.
Spiess says that, according to Morningstar, “The average ESG US stock exchange-traded fund (ETF) charges 0.17% in annual fees … 0.05 percentage points more than non-ESG funds”.
Spiess’ article also quotes Fitz’s data, showing that average assets under management in sustainable bond funds nearly quadrupled in Europe in 2022, but traditional bond funds attracted US$3.3bn, down nearly 6% from 2021.
ESG winning streak ends
An article in The Wall Street Journal by Jason Zweig, excerpts of which are reproduced in a blog, points to strong flows in recent years for ESG equity funds. Zweig says that over the five years to the end of 2022, “investors added an estimated US$64.6bn” to mutual funds and ETFs using ESG strategies to invest in US stocks, while “they yanked US$92.2bn from all other US stock funds combined”.
Zweig points out that ESG funds tend to favour “software and healthcare, while tilting away from oil and gas”. He cites Morningstar data which shows that “sustainable US stock funds have 22.1% of their assets in technology and 15.4% in healthcare”, alongside just 2.6% in energy. Non-ESG funds hold 18.7% of theirs in tech, 14.3% in healthcare and 5.7% in energy.
“No wonder green funds outperformed over the past five years, earning an average of 8.1% annually, while non-sustainable funds grew at 6.9%,” says Zweig. For most of that period, energy lagged but tech and healthcare boomed.
However, Zweig points to a turnaround in 2022, when tech stocks tanked and energy stocks were among the few sectors to buck the downward trend. “Green funds lost 19.7%, faring even worse than conventional funds, which fell 18.1%,” he says.