Socially responsible investing doesn't have to cost more.
Socially responsible investing, also known as sustainable, impact, or ESG (environmental, social, and governance) investing, has been steadily growing in popularity in recent years. A year ago, we launched the Morningstar Sustainability Rating for funds to help investors measure to what extent any mutual fund's portfolio aligns with ESG principles.
One concern that frequently arises among those new to this type of investing is performance, specifically whether investors have to sacrifice returns if they invest sustainably. Many people have assumed that the answer must be yes, but in fact there is no good evidence of any significant performance difference between sustainable and nonsustainable mutual funds, as Morningstar director of sustainability research Jon Hale has noted in a couple of recent studies. Similarly, an article from 2012 surveys the academic literature showing no significant performance penalty for sustainable funds.
Another concern that sometimes surfaces is price. Are sustainable mutual funds more expensive as a group than nonsustainable funds? Do investors have to pay up for ESG screening? This question hasn't been investigated as extensively as the performance one, so we examined it in a couple of different ways using Morningstar data.
Comparing Average Expense Ratios
The most straightforward way to examine this question is to directly compare the average expense ratios of sustainable versus nonsustainable funds. To do so, we divided funds within each Morningstar Category into those tagged as "socially conscious" in our database versus all others, and then looked at the most recent annual report net expense ratio for each fund or share class. We excluded index funds for the purposes of this study to provide a more apples-to-apples comparison, because the vast majority of ESG fund assets (more than 90%) are actively managed.
Exhibit 1 shows the result if we simply calculate a straight average of all the expense ratios in each group. This exhibit includes seven Morningstar Categories with at least 20 different ESG fund share classes. (Other categories have too few ESG funds for useful results.) The two columns show the average expense ratio of the ESG and non-ESG funds in each category, with the number of share classes in each group in parentheses.
For all the categories except Allocation--50% to 70% Equity, the average expense ratio for ESG funds is lower than the average for non-ESG funds. That looks encouraging, but there are some caveats. These groupings lump together all share classes and treat them equally, ranging from no-load and institutional shares to expensive shares with high 12b-1 fees. The lower average for ESG funds could just mean that they're less likely to have these expensive share classes, because of the way they're distributed. Asset-weighted averages, in which share classes are given a greater weighting in proportion to their size, give a better idea of what investors are actually paying. Exhibit 2 shows the asset-weighted average expense ratios for ESG and non-ESG funds in the same seven categories: