Financial literacy is more likely to account for retail investor willingness to pay higher fees for sustainable funds than social preferences, according to research by academics at the Universities of Kassel and Amsterdam.
The working paper examined fee sensitivity and sustainable investment allocation across 5,162 investors in the Netherlands, Germany, France, Spain and Poland.
It found that sustainable investors with low financial literacy “react insensitively to higher fees on sustainable investments”. Conversely, investors with high literacy reduce their sustainable investments “if they become relatively more expensive compared to conventional investments”.
The study was carried out by University of Kassel researchers Daniel Engler and Gunnar Gutsche, and Paul Smeets, professor of philanthropy and sustainable finance at the University of Amsterdam.
Participants were given the opportunity to allocate funds between ETFs based on the MSCI World and the MSCI World ESG screened index, and again between the MSCI World and MSCI World Climate Change Index. They were shown a short description of the indices and information on fees, with the MSCI World costs fixed at 20 basis points and varied fees charged on the sustainable ETFs, ranging from 20bps to 230bps.
The study assessed participants on their social preferences, asking how willing they were “to give to good causes without expecting anything in return”, and on their general financial literacy and understanding of the impact of fees on investment returns.
Just over 15 percent of respondents incorrectly calculated the impact of fees, while around 7 percent answered “do not know”, described by the researchers as “a quite substantial share”.
For situations where the sustainable ETF and the MSCI World ETF charge the same fees, participants invested an average of 56 percent in the sustainable ETF, falling to 52.7 percent when the fees were 90bps, 50.6 percent when they were 160bps and 48 percent where the sustainable ETF charged 230bps.
While investors with stronger social preferences allocated more to the sustainable funds, allocation to sustainable funds decreased at a similar rate to investors with weaker social preferences as fees increased, which the researchers said implied that fee sensitivity on sustainable investments “is not driven by social preferences”.
However, analysis of the results showed “strong evidence” for the impact of financial literacy on fee sensitivity, with sensitivity increasing with higher levels of financial literacy.
There was a similar pattern for respondents who were unable to calculate the impact of fees on returns. Those who calculated fees correctly invested 5 percentage points more in a low-fee scenario and 6 percentage points less in the highest-fee scenario.
The researchers also highlighted several findings within the wider results.
Firstly, investors who expected a higher return from the sustainable alternative allocated a higher proportion to it, while investors who perceived it as higher risk invested less. Women and Catholics also invested a higher proportion sustainably than men and respondents without a religious affiliation, respectively.
Commenting on the results, the researchers said that social preferences play an important role in deciding how much to allocate to sustainable investments, but do not explain fee sensitivity.
The results have important implications for sustainability preferences under MiFID II, the researchers say.
They note that ESMA and consumer organisations have both raised concerns that institutions can use knowledge of client sustainability preferences to charge higher fees.
“This is a particular concern for individuals with low financial literacy,” the researchers said. “These individuals do not make a conscious choice to pay higher fees because they want to contribute to a better world but they simply do not understand the impact of higher fees for their net returns.”
The results also have “important implications” for asset pricing, as they speak against financial models which postulate that decision-making is grounded solely in risk-return considerations. The willingness for investors to pay for stocks of sustainable firms “could translate into lower capital costs”, the researchers added.