Financial advisors exploiting SRI investors on fees, research suggests

Study of US advisors finds unjustified premiums for retail clients seeking SRI strategies

Exploitative practices by financial advisors appear to play a role in premiums associated with socially responsible investment strategies (SRI), according to a study that found additional charges for such strategies “cannot be justified by higher effort, skill, or costs”.

The research, which involved 345 US-based advisors, was conducted by three academics from Maastricht University’s School of Business and Economics and the Vrije Universiteit Amsterdam.

The authors question the claim often made by financial advisors and investment professionals that SRI strategies carry additional charges simply because of the extra hurdles and costs involved in creating and running them.

In order to test this, they structured the study so as to remove the possible justifications for higher fees – for example, by providing SRI data for free. 

Participating financial advisors – who were not named in the final report – were asked to select stocks from the Dow Jones Industrial Average index for retail clients with a budget of $1k. The study observed 1,380 client-advisor interactions, with half seeking SRI mandates and the other half conventional ones.

Once the advisors had selected stocks for their clients, they were asked to set a fee for their service of between 0-4% of the total invested. The advisors still charged higher fees (between 4.9 to 6.7 basis points) for clients seeking SRI strategies, despite the mitigation of cost variables between the two types of strategy. 

“In this setting we can therefore infer from the higher fee for SRI clients that an intent exists for price discrimination that exploits clients’ responsible investing preferences”, the academics wrote.

The study also found that “socially responsible clients are equally likely to take on the advice as are conventional clients, even if they are charged a higher fee”.

Although the research focused on US investors and advisors, the authors stress their findings have implications for the EU’s sustainability push – particularly in respect of incoming changes to the Markets in Financial Instruments Directive (MiFID II) to require financial advisors to ask clients’ preferences around sustainability. 

“Our study shows potential unintended consequences of regulations involving SRI mandates. Specifically, it shows that financial advisors exploit clients with a socially responsible mandate by charging them higher fees that are not justified by costly effort,” they said.

The findings were shared with 53 European-based regulatory specialists, including individuals from the Dutch Central Bank (DNB), the Dutch financial regulator Authority for Financial Markets (AFM) and the compliance departments of several European banks. 

A survey of those specialists revealed that the majority believed that premiums associated with SRI are due to additional work involved – an assumption that the authors’ paper challenges.

Over 80% of those polled also said that the findings of the study requires attention from policymakers. 

The academic behind the study also attempted a “back-of-the-envelope analysis” to estimate the “potential market-wide effects of the fee differences”. They estimate that for retail clients in the US, excess fees associated with SRI strategies for 2020 could be in the region of $2.23bn. For US funds employing SRI strategies, including those used by institutional investors, the excess fee tally for 2020 was estimated at $8.38bn.

“Even if our effect size is just an indication, we consider this premium to be economically meaningful,” the authors wrote. 

The academics behind the paper are: Utz Weitzel, Professor of Experimental Finance at Vrije Universiteit Amsterdam; Paul Smeets, Professor of Philanthropy & Sustainable Finance; and Marten Laudi, PhD Candidate in Experimental Finance at Maastricht University, School of Business and Economics.