European regulator seeks to explain ESG funds’ mysterious outperformance

New research aims to determine how ESG funds tend to be cheaper than non-ESG funds while also outperforming.

The European Securities and Markets Authority (ESMA) published a paper examining the differences in cost and performance between ESG and non-ESG retail investment funds (not including ETFs).

The research follows previous studies from the regulator that showed ESG equity funds were cheaper on average and performed better than non-ESG funds in 2019 and 2020.

“Understanding how ESG funds can charge lower fees and outperform non-ESG funds is key as it could provide some insights on how to make the overall fund industry more affordable and profitable for retail clients,” the paper said.

The analysis found several fundamental differences between the categories of funds, including that ESG funds generally favour large-cap stocks and are more oriented towards developed economies, and that “these exposures are correlated with lower ongoing costs.”

The research also found that there are differences in the sectoral exposures between ESG and non-ESG funds, with ESG funds having higher exposures to the tech and health-care sectors.

However, even after controlling for these differences, the researchers concluded that “ESG funds remain statistically cheaper and better performing than non-ESG peers.”

Further research is needed to identify the other factors driving these underlying cost and performance differences, it said.

“Monitoring the evolution of costs will be all the more important as on the ESG side, the market is still developing and might quickly evolve,” the paper said.

Additionally, the analysis also discovered that funds that are created as ESG funds from the start are the cheapest, followed by funds that were initially non-ESG and were converted to ESG. And it found that “impact” funds are cheaper than other types of ESG funds, but that they don’t outperform other sorts of ESG funds.

Staff

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