ESMA Risk Analysis: The drivers of the costs and performance of ESG funds
The European Securities and Markets Authority (ESMA) published a study confirming that funds which include environmental, social and governance (ESG) features were cheaper and better performers compared to non-ESG funds.
In a bid to inform the fund industry on how to make funds more affordable and profitable for retail investors, ESMA considered the possible drivers behind this finding. They found that ESG funds remain comparatively better performing and cheaper, even after controlling for differences in sectoral exposures and portfolio composition, such as ESG funds’ orientation towards large cap stocks and developed economies. Further research is required to identify other drivers.
Rationale for Study
An understanding of the costs and performance of funds (both strongly linked) allows investors to make informed decisions and fosters the continuation of increased retail participation in capital markets.
Past analyses of differences in costs and performance between ESG and non-ESG funds found that, even after controlling for the relative youth, growing popularity and larger size of ESG funds, and their comparative share of passive funds, ESG equity UCITS[1] (excluding exchange-traded funds) remained on average cheaper and better performers than their non-ESG peers in 2019 and 2020.
ESMA’s study builds on this by seeking to identify the impact of other drivers, such as:
- Portfolio Composition, including the size of underlying issuers and any bias towards developed economies. Larger caps are generally associated with higher liquidity which may lower trading costs, and investment in emerging markets can be associated with higher costs.
- Sectoral Differences, for example, the hypothesis that ESG funds are more exposed to the healthcare sector which performed well during the height of the COVID-19 crisis.
The study comprised analysis of a homogeneous sample of 6,528 EU-domiciled, equity UCITS (excluding exchange traded funds) during the period April 2019 to September 2021.
Portfolio Composition: Ongoing Costs
Comparisons of exposures to specific allocation categories in ESG funds and non-ESG funds:
1. LARGE CAPS VERSUS SMALL CAPS
As of September 2021, ESG funds remained more exposed to large caps and less exposed to small caps.
2. VALUE STOCKS VERSUS GROWTH STOCKS
As of September 2021, non-ESG funds were more exposed to value stocks and ESG funds were more exposed to growth stocks.
3. GEOGRAPHICAL EXPOSURES
In April 2019, on an aggregate level, the exposure to developed economies was similar, but ESG funds became more exposed to this area during 2019-2021 and, as of September 2021, the difference was statistically significant.
4. SECTORAL EXPOSURES
Between April 2019 and September 2021, UCITS equity funds increased their exposure to communication services (to a greater extent for non-ESG funds) and healthcare stocks (to a greater extent for ESG funds), and partially divested their consumer defensive, energy and financial stocks (to a greater extent for ESG funds).
