In the US, one in three dollars of assets under management is now invested sustainably. Prominent media have been critical of asset managers for charging higher fees to sustainable investors. For example, the Wall Street Journal has already proclaimed sustainable investing to be a new cash cow, through which additional fees can be earned at no extra cost to the managers. A similar picture exists in the EU, where recent amendment to the EU’s Markets in Financial Instruments Directive II (MiFID II) now requires professional financial advisers to ask their clients about their Socially Responsible Investing (SRI) preferences. Investor protection authorities such as the European Securities and Markets Authority (ESMA) and consumer organisations share the media’s concerns about where this could lead. They think that financial advisers can exploit customers with a high willingness to invest sustainably by selling them more expensive products.
In contrast, most asset managers claim to be unaware of potential conflicts of interest linked to sustainable investment preferences and argue that policy interventions are not necessary. They point out that sustainable investment products can be more expensive to manage than conventional products, for example due to the costs of screening companies for sustainability. Despite the criticisms from media and regulators, empirical evidence that sustainable investors would be disadvantaged was lacking – until now.
Even less time
Smeets and his colleagues Marten Laudi and Utz Weitzel conducted two experiments among 415 financial advisers in the US and Europe. They discovered that advisers did indeed charge higher fees to sustainable investors compared to conventional investors, and there appeared to be no logical explanation for the difference. Smeets: ‘The financial advisers did not invest more time and energy in their sustainable investment clients and did not have more skills compared to the skills required for conventional investing.’
The researchers reproduced their findings in the second experiment. ‘We saw that the advisers spent even less time on their sustainable clients. Both in terms of time spent and in terms of information considered, advisers make the same or even less effort for sustainable investors,' says Smeets. ‘It seems that advisers are focusing almost exclusively on the relatively simple ESG ratings (Environment, Social and Governance) for sustainable mandates, while considering a broader set of financial information for conventional investment mandates. This indicates that the higher fees are the result of price discrimination to extract extra profit from sustainable investment clients.’
The researchers also saw that the advisers charged a higher rate in particular to sustainable investors with little financial knowledge or if they knew nothing about the financial knowledge of the client. Smeets: 'The higher fee is not there if the adviser knows that the financial knowledge of the sustainable investment client is extensive.'
Policy interventions necessary
In a separate study, the researchers collected survey data from 53 professionals working in regulation, policy-making and supervision in the financial sector. The professionals did not predict the results of the research in advance. After learning about them, they all indicated that policy interventions were necessary. Smeets endorses this: ‘With sustainable investing, the expectation is that the financial return will be lower in any case compared to conventional investing. In combination with higher rates, this threatens the attractiveness of long-term sustainable investments and that is a cause for concern.’
Marten Laudi, Paul Smeets and Utz Weitzel: ‘Do Financial Advisers Charge Sustainable Investors a Premium?’ (SSRN working paper, 24 November 2022)