The environmental, social, and governance strategies that are most likely to attract investor money aren’t necessarily the ones that are best at managing ESG risks — but the ones that are the cheapest.
ESG funds that charge higher fees have seen an average outflow of capital from August 2018 to September 2021, while ESG funds with lower fees have seen an average inflow of capital during the same period, according to a recent paper by André Wattø Sjuve, a scholar from Norwegian School of Economics. The study shows that investors in the more expensive ESG funds are “more active in seeking out the cheaper alternatives,” Sjuve told II in an email.
Sjuve’s findings suggest that ESG managers face fee pressure just like other active managers. While active management fees have declined over the past few years as passive investment vehicles became more popular, traditional wisdom says that ESG strategies should be more immune to fee compression because they require specific active management skills. Sjuve’s study, however, paints a different picture.
“Investors view sustainability as a positive attribute, but how sensitive their demand is to changes in economic conditions remains an ongoing inquiry,” Sjuve wrote in the paper. The fact that expensive ESG funds have been struggling to keep investors implies that economic concerns can be a top reason for investors to steer away from sustainable funds, he concluded.
Sjuve also found that investors in funds with higher ESG ratings are more sensitive to fee changes than those who invest in funds with lower ESG ratings. He studied the capital flow data of over 16,000 mutual funds on Morningstar, where funds are rated on a scale of one globe to five globes depending on their ESG performance. According to the paper, a one standard deviation increase in fees led to a net outflow of 43 basis points for five-globe funds and only 11 basis points for one-globe funds.
Sjuve said one possible explanation for the fee sensitivity around ESG funds is that the prices of ESG assets have exploded in recent years, and investors might be more concerned about the prospects of future returns. “To maximize the probability of seeing their capital grow, they have to be more conscious about the fees they are charged,” he said.
Yet for ESG funds with more specific mandates, it’s still possible to raise fees without losing investors, according to the paper. “Some funds have an explicit sustainability mandate and others are focused on having portfolios aligned with individual ESG pillars,” Sjuve wrote. For such funds, he found that investors are more willing to overlook higher fees to achieve specific ESG goals.