Good news: ESG funds are cheaper

Last week, I wrote a depressing post pretty much every day of the week. To make it up to my readers, I decided to focus on good news stories this week and I’ll start with some good news that I found genuinely surprising: ESG funds in the US are on average cheaper than non-ESG funds and have higher returns.

Aaron Black and Julian Kölbel examined a total of 44,220 share classes of equity funds registered for sale in the US between 2011 and mid-2024. About 1,600 of these share classes were ESG fund share classes. For each share class, they looked at the fees charged and other key variables like the age of the fund, size, etc.

Conventional wisdom has it (and I was under this impression as well until I read their paper) that ESG funds are more expensive than non-ESG funds because they can charge higher management fees due to the extra layer of analysis involved in their management. And if you look at gross expense ratios (management fees + admin costs + distribution fees + other fees) ESG funds are on average more expensive than non-ESG funds. The average gross expense ratio of ESG funds in their analysis was 1.48% of assets under management per year. The average gross expense ratio of non-ESG funds was 1.34%.

But if you look beyond this ‘sticker price’ at what investors paid, the picture flipped. The net expense ratio after fee waivers for ESG funds was 0.85% and for non-ESG funds, it was 1.01%. Fee waivers granted by the asset manager to investors were about twice as large for ESG funds (0.63%) than for non-ESG funds (0.33%). Meanwhile, the average monthly performance after fees of ESG funds (0.64%) was higher than for non-ESG funds (0.54%). You get higher returns for lower costs with ESG funds.

Gross and net expense ratios of ESG and non-ESG funds

Source: Black and Kölbel (2024)

If the fee waivers are so much larger for ESG funds than non-ESG funds it begs the question of what is going on. The authors of the study find indications for three drivers though no conclusive evidence for either.

First, they find that investors who buy ESG funds expect them to offer lower returns than conventional funds and asset managers try to alleviate these concerns by giving investors larger fee reductions. Second, because there is a bigger overlap in investments between any two ESG funds than any two conventional funds, there is more competition between ESG funds to attract investor assets. This incentivises larger fee reductions. Third, there seems to be some cross-selling effect going on where asset managers use ESG funds as a way to attract new investors who can then be enticed to invest in other funds of the same asset manager that have higher fees.