Fees for ESG investments in Europe moving downward

Money managers racing to gather environmental, social and governance assets as European asset owners shift to all-ESG portfolios will have to absorb the cost of integrating specialist data if they want to remain competitive on fees, which in Europe are already lower than for non-ESG investments.

A European fee study by Morningstar Inc. published Dec. 7 showed that fees have fallen more for all ESG strategies compared with their non-ESG counterparts over the last seven years.

As of October, the asset-weighted average fee for all ESG funds — defined by having ESG language in the fund description — was 0.57% vs. 0.71% for non-ESG funds, according to Morningstar figures — a mix of institutional and retail data. The equal-weighted fee for ESG funds was 0.93% vs. 1.21% for non-ESG funds.

In the asset-weighted category, the average fee for ESG funds has fallen by 42% and by 29.6% for non-ESG funds since 2013. In equal-weighted terms, the average fee for ESG funds dropped by 29% and for non-ESG by 17% over the same period.

Sources said that new European disclosure rules such as the Sustainable Finance Disclosure Regulation, effective in March 2021, will push investors to further align their portfolios with carbon reduction targets. In the new year, money managers expect European investors to focus on largely buying funds that are compliant with disclosures under Article 8 and Article 9 of the SFDR that promote environmental and social factors as well as those aimed at having a sustainable impact, respectively, rather than traditional non-ESG funds.

But to attract business to their strategies, money managers will have to make some sacrifices when it comes to fees.

"What is ESG investing today will be the standard (in the future). You cannot have higher fees," said Steffen Kutscher, senior advisor investment and ESG advisory Europe, Middle East and Africa and Asia-Pacific in the product division at DWS Group in Frankfurt. He said that investors at the very minimum want to buy Article 8 strategies from March 10, 2021. "Every manager is in a horse race, trying to catch up," he added. "You can see that many managers are trying to push out strategies with lower fees to catch more flows," he said.

Sonja Laud, CIO of Legal and General Investment Management Ltd. in London, added: "ESG integration is now an extensive feature to any investment process."

"Clients do expect that investment decisions take (into) consideration a broad set of ESG factors," she added. And because ESG investing is becoming synonymous with mainstream investing, she said a "fee premium might not be sustainable in your core product ranges," she said.

Sources said that in addition to the already-existing fee pressure stemming from manager competition, regulatory requirements have additionally forced managers to absorb the costs of integrating ESG data into their investment process to offer appropriate funds for European investors.

"Now to be competitive, managers have to be careful not to price themselves out of a market," said Mark Fitzgerald, head of product specialism at Vanguard Asset Management Ltd. in London. Mr. Fitzgerald noted that with a mixture of ESG approaches, ranging from exclusions to funds identifying leading ESG companies, managers could still charge up to a 10 basis points premium.

"The fees on the larger (ESG) launches are competitive with mainstream products. There is a slight premium if you are (comparing an ESG product to) a large stable mature index fund," he said.

"If you go back a few years, there were fewer products on offer, and there was more differentiation between non-ESG products and ESG products," he added.

While Vanguard expects to benefit from scale and lower its ESG fund fees, currently at between 0.14% and 0.2%, DWS doesn't differentiate fees for active ESG funds and active non-ESG funds.

On average, fees for active ESG funds in Europe are lower than those for active non-ESG funds, while fees for passive ESG funds are slightly higher than those for non-ESG passive funds, Morningstar's study also found. Asset-weighted non-ESG passive funds charged a fee of 0.19% in 2020 compared with 0.25% charged by asset-weighted ESG passive funds.

However, non-ESG passive equal-weighted funds charged on average fees of 0.32% in 2020, whereas equal-weighted passive ESG funds also charged 0.32%.

One example of the need to absorb costs related to data integration, according to DWS's Mr. Kutscher, is that ESG ETFs can be more expensive than their traditional counterparts because it is more expensive for managers to cover the cost of ESG indexes. Mr. Kutscher added that index providers will add additional charges if their efforts take more work, for example, in devising or executing a strategy to measure carbon intensity or overweighting companies with a specific carbon reduction target.

But even with the cost of data pushing overall manager costs up, managers are finding ways to profit. Speaking about passive managers incorporating active approaches, Dimitar Boyadzhiev, senior analyst, passive strategies research Europe at Morningstar in London said: "It is a clever thing."

"If you want to structure an ETF you can still make a product that is very cheap and (incorporate) ESG on 20% of the portfolio actively using your own internal research and offer a lower price this way," he said.

"If you have two very strong data providers in the market, they (would) try to charge more (for data)," he said. But he added: "An active implementation allows you to stay competitive."

Luba Nikulina, global head of research at Willis Towers Watson PLC in London, said that when managers allocate more resources and do additional work they can try to justify higher fees. But she said: "Considering where managers' margins are, there is still room for fees to go down especially (...because) some larger managers get more scale which allows them to allocate the cost of data across a larger amount of capital and hence bring down costs for themselves and decrease the fees."

Investors can buy funds with a broad integration of ESG for as little as 7 basis points, Mr. Boyadzhiev said. Funds that utilize more ESG research and climate tilts would cost about 20 basis points, he added.

Mr. Boyadzhiev added that non-ESG ETFs such as strategic beta ETFs or multifactor ETFs are causing the price of non-ESG strategies to tick upward.

"The cheapest global equity income dividend ETF (costs) 29 basis points whereas you can buy a global large cap tracker for 12 basis points," he added.

Still, LGIM's Ms. Laud said that there are areas such as climate-change-related funds or funds reflecting on specific values stemming from the United Nations' Sustainable Development Goals that could justify managers charging higher fees because they focus on capturing a specific risk.