Weighing The Costs of ESG Investing

How much does it cost to feel good? What does it take for us to be truly happy in life? These may sound like some pretty deep questions to ask yourself and they are.  But, you know, I had the opportunity to ponder these recently during the Christmas break. Sophie is home from Bryant University for the break and we got to talking about an assignment from her sociology class about money and human values. She found the course fascinating, and I naturally found ties to investing.

Of course, "happiness" is subjective but many studies have been done to help answer the question of money and how it relates to our happiness. For example, a recent study from Purdue University attempted to answer this question by measuring emotional well-being and life satisfaction. One of their findings was that globally, the ideal income point for an individual is $95,000 for life satisfaction and between $60,000 to $75,000 for emotional well-being. In North America, the individual income level for life satisfaction was found to be $105,000 per year₁. 

Hmmm . . . I got thinking.

So, I decided to dig into this topic a little deeper as it relates to the specific investments that we make, especially in today’s environmental and political climate, and I’d like to spend our time this week on the topic of ESG investing.

Now, it’s widely reported in the media that many companies are increasingly setting ambitious sustainability or other ESG targets. ESG stands for Environmental, Social and Governance and refers to the three key factors when measuring the sustainability and ethical impact of an investment in a business or company. A growing number of individual investors are also starting to evaluate companies using ESG criteria to screen their own investments as a way to support their personal social agenda.

At face value, this sounds like a reasonable vetting process for your hard-earned money. Why wouldn’t someone consider an investing in companies that have pledged to support industries that focus on making the world a better place? But unfortunately it’s not that easy. 

One key consideration is cost. There are significant financial costs involved in realizing these new sustainability ambitions. In fact, Morningstar has said that investors in sustainable funds are paying a “greenium” relative to investors in conventional funds. In a recent study by them, they found that ESG funds have a higher asset-weighted average expense ratio, which stood at 0.50% at the end of 2022 versus 0.37% for their traditional peers₂. 

Consider the fact that a 2021 analysis by Bloomberg forecasted that ESG assets are on track to exceed $53 trillion by 2025, more than one-third of the estimated global assets under management. Folks, this adds up to an amazing “greenium” amount₃.

In my experience, most investors who purchase ESG-oriented investments don’t realize how much they are paying. At the average ESG fund, the fees can be up to three times what’s reported, according to a new study. That’s because these funds—also often called green, sustainable or responsible—are nowhere near as pure as they purport to be. The average green U.S. stock ETF charges 0.17% in annual fees, according to Morningstar—0.05 percentage points more than conventional funds₄. 

Charles Schwab says one way to measure the performance of ESG funds is to see how their performance ranks relative to funds in the same Morningstar category. A fund that ranks in the 1st percentile for a three-year period has done better than all of the other funds like it over that time, while a fund that ranks in the 100th percentile has done the worst of all of its peers. If ESG funds were systematically at a disadvantage thanks to sticking to ESG principles, they would rank between the 50th and 100th percentiles time after time.  Not a very good winning streak₅.

It’s also important to question the composition of any ESG investment you’re considering, too. For example, according to a new Harvard study, ESG funds have, on average, 68% of their assets invested in “the exact same” holdings as non-ESG funds₇. This means that only about a third of your money in the average ESG fund is distinctly “green,” yet you will incur the higher fees on the entire portfolio. So essentially you’re paying three times more in fees for a fund that that may be only about 30% green. 

Another consideration is to determine the funds risk budget.  In other words how much risk are you absorbing and what is the funds downside risk mitigation system.  After the carnage of the 2022 markets, what we don’t want to do is just buy and hold with no triggers to mitigate risk.

Folks, I’m not trying to dissuade anyone from their efforts to make the world a better place or from investing in ways that contribute to your life satisfaction. But make sure you enter into each investment with your eyes open and all of the facts in front of you. Only then can you truly evaluate if your investing style will add to both your retirement income and your long-term happiness. 

And as always - be vigilant and stay alert, because you deserve more!

Have a great week.

Jeff Cutter, CPA/PFS is President of Cutter Financial Group, LLC, an SEC Registered Investment Advisor with offices in Falmouth, Duxbury, and Mansfield, MA. Insurance offered through its affiliate, CutterInsure, Inc.

We do not offer tax or legal advice. Jeff can be reached at jeff@cutterfinancialgroup.com. This information is intended to provide general information. It is not intended to offer or deliver investment advice in any way. Information regarding investment services is provided solely to gain a better understanding of the subject of the article. Different types of investments involve varying degrees of risk, including the potential for loss. Therefore, it should not be assumed that future performance of any specific investment or investment strategy will be profitable. Insurance product guarantees are backed by the financial strength and claims-paying ability of the issuing company. Market data and other cited or linked-to content is based on generally available information and is believed to be reliable. Cutter Financial does not guarantee the performance of any investment or the accuracy of the information contained in this article. Cutter Financial will provide all prospective clients with a copy of Cutter Financial’s Form ADV 2A, Appendix 1, applicable Form ADV 2Bs and Form CRS as well as the firm privacy policy. Please contact us to request a free copy via .pdf or hardcopy. 1. https://tinyurl.com/y3pn2nh3 2. http://tinyurl.com/2s42ht68
3.  http://tinyurl.com/49hkh8bm 4. http://tinyurl.com/2s42ht68 5. http://tinyurl.com/4kvp65f6 6. http://tinyurl.com/263vt94e