ESG Funds perform better with lower costs – ESMA asks why?

PUBLISHED: 15th June 2022

Photo to illustrate article

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:

  1. 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.
  2. 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).

Low-Cost Drivers in ESG Funds

The study deployed a “regression analysis” of ongoing costs and gross performance, including domicile, management style, target client, size and sectoral exposure, and sets out the equation and dependent and independent variables used. 

It confirmed the relative cheapness of passive funds, funds targeting institutional clients, larger funds, and increased exposure to developed economies or large caps.  It also confirmed that funds of funds and older funds are associated with higher costs.  However, while ESG funds were found to be on average less exposed to small caps and more oriented towards developed economies, which could contribute to lower fees, ESG funds remained cheaper even when controlling for portfolio composition differences, by 0.080 percentage points.    

Funds created as ESG were cheaper than non-ESG funds, followed by funds that converted to ESG, with the smallest difference being evident between older ESG funds and non-ESG funds.  Converted ESG funds were found to be cheaper following their conversion.

Impact funds and those following other ESG strategies were found to be cheaper than non-ESG funds, with impact funds appearing to be the cheapest category.

Sectoral Exposure: Monthly Gross Performance

An investigation into the drivers behind the outperformance of ESG funds found that differing sectoral exposures (such as target clients, investment in other funds or investment in higher-performing health, energy, financial, industrial or technology sectors as compared to lower-performing consumer defensive and utilities sectors) cannot entirely explain the outperformance of ESG funds.  ESG funds still outperformed non-ESG funds even after controlling for those sectoral exposures.  Indeed, ESG funds significantly reduced their exposure to the financial sector, which was the best performing sector during the control period.

The regression showed that older ESG funds (created before 2019) outperformed non-ESG funds.  However, the performance of newer (created or converted) ESG funds did not differ significantly to non-ESG funds.  Impact funds outperformed non-ESG funds at an insignificant level and there was little difference between impact funds and those employing other ESG strategies.  Even if impact funds and those created as ESG have the lowest fees, they do not outperform non-ESG funds in net terms.

Furthermore, a higher exposure to carbon or environmental risks was associated with greater performance.  The analysis found that funds focusing on the S or G pillars of ESG strongly outperformed non-ESG funds (with S presenting as the best performing category), whereas the performance of E funds was not statistically different to non-ESG funds. 


The study confirms that ESG funds are generally more exposed to large caps and more oriented towards developed economies, which (along with funds targeting institutional clients, passive funds and more recent funds) are associated with lower costs.  However, ESG funds remain cheaper even after controlling for these factors.  In addition, funds created as ESG funds present on average as cheaper than those that were converted to ESG, and impact funds are cheaper than ESG funds employing other ESG strategies. 

The study also demonstrates that differences in sectoral exposure were not the only drivers of ESG funds’ outperformance, and funds created as ESG and impact funds that were amongst the cheapest were not the best performing funds.     

Finally, funds focusing on the S and G pillars were associated with higher performance in comparison to those focusing on the E pillar.

What Next?

ESMA will continue to monitor the evolution of costs in an ever-evolving ESG market, and consider to what extent the relative cheapness of ESG funds will impact the costs of non-ESG funds.  ESMA has flagged the need for further research to more fully understand the contributing factors behind the relative cheapness of ESG funds, including whether ESG funds remain cheaper when total (and not just ongoing) costs are considered.   Such research will, however, be constrained by a lack of data.  It has also suggested an analysis of environmental/social performance alongside financial performance; as well as a study of risk-adjusted performance to see if the higher performance of ESG funds still holds.

ESMA’s press release accompanying this study can be viewed here.  For further information, please contact David Naughton at or Katrina Smyth at


[1] Undertakings for Collective Investment in Transferable Securities

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