Fees fall significantly in some ESG and impact strategies

The investment consultant said pricing compression was evident in well-established strategies such as ESG equities and renewable energy infrastructure. Meanwhile, it said newer strategy types such as impact equities and the so-called ‘dark green' article nine funds were offering substantial discounts versus rack rates.

The study's key findings include a reduction in the cost of active global equity strategies with ESG requirements, where the median fee for a €100m (£85m) mandate has decreased by 14% since 2016.

It said that more managers have entered the space through a period of "ESG mainstreaming" - something that has resulted in heightened competition for assets and a refinement in pricing.

And it said that, while manager research suggests that there could be a modest premium for impact and article nine equity strategies, managers in these more nascent sectors are more likely to offer substantial up-front discounts even before negotiation, as they seek to build up assets.

Elsewhere in the ESG-related landscape, management fees for renewable energy infrastructure strategies have fallen by 8% since 2016 and performance fees have also declined - at a period when it said fees for infrastructure strategies and private markets strategies more broadly had remained "remarkably resilient."

Bfinance said that, when looking at other strategy types, US high yield had seen median fees decrease by 15% since 2017, while fees for blended emerging market debt strategies decreased by 10% in the same period. Multi-sector fixed income also saw its median fee decrease by 15% since 2017.

Fund of hedge fund fees declined very substantially, falling by 42% between 2010 and 2019, but this decline now appears to have stopped. While it said fees for private markets strategies have remained relatively resilient, a closer look at fee models does reveal some changes - with, for example, direct lending fees now almost universally charged on invested capital only rather than on both invested and committed capital.

Bfinance head of investment content Kathryn Saklatvala said: "The fourth instalment of our investment manager fees series once again puts fee reductions in focus while honing in on some specific asset classes.

"In the light of investors' growing interest in ESG and impact strategies, it is particularly interesting to see some very significant reductions in the fees that managers are quoting for clients. We will be keenly watching how pricing evolves for some of the more nascent sectors, such as article nine funds and impact real estate, where there is more uncertainty around what an appropriate fee should look like."

The price of ESG and impact

The research from Bfinance found that investors can benefit from a notable erosion in fee levels for a number of ESG and impact-oriented strategies. Some ESG-related sectors are now becoming relatively mature, often characterised in pricing terms by narrower dispersion in fee quotes and more clustering around certain fee-points as well as overall price compression.

Active global equity managers that integrate ESG considerations are now quoting significantly lower fees to prospective clients than five years ago. The median fee quoted by managers on €100m mandates has declined by 14% since 2016, from 57bps to 50bps.

The study found that the rapid reduction in the number of active global equity strategies that do not integrate ESG considerations has negated any potential ESG pricing premium in this asset class.

Dedicated thematic and impact equity strategies

Bfinance said there are also some interesting patterns in pricing of impact and thematic equity strategies that investors may consider as they explore these emergent sectors and negotiate fees. For example, it said recent search activity in this space (Q4 2021) suggested there may be an on-paper premium on the pricing of article nine strategies, with a slightly higher median and a significantly higher upper quartile fee than it observed in article eight strategies.

However, this area also featured some of the most aggressive discounting against those quotes, with nearly 30% of the managers proposing article nine strategies offering an upfront discount (i.e. a discount provided alongside quoted fee in first proposal). Bfinance said these upfront discounts were primarily available from managers whose pricing sits above the median - and often came as managers were seeking seed investors and competing to gain a foothold in this growing space.

It said there may also be a modest premium (or at least a higher median quoted fee) for impact strategies, which explicitly target and are equipped to report on social and environmental outcomes. ESG thematic strategies that do not meet the threshold which Bfinance would consider appropriate for an impact strategy were, it said, a little cheaper in terms of quoted fees on average.

Renewable energy Infrastructure

As the renewable energy infrastructure sector has matured and developed, Bfinance said investors have benefitted from some significant fee reductions—contrasting with stable infrastructure pricing in other sectors.

The research found a modest reduction in quoted base fees for global renewable energy infrastructure strategies, with the median quoted fee for a $50m (£37m) mandate down 10bps versus 2016 (-8%) and a fall of 21bps in the upper quartile (-14%). The survey also saw significantly less dispersion in the fees being quoted by managers—a pattern that Bfinance said is characteristic of a maturing sector, where price discovery over time leads to a greater awareness of what competitors are likely to charge for similar products and a reduction in the more extreme quotes.

Importantly, Bfinance said performance fees and hurdle rates have also fallen. While many managers are at the 20% mark on carry, it said it does see an increasing proportion willing to price between 10% and 15%. In addition, it noted the median hurdle rate has declined to 6% from 7%.

The decline in fees has, however, been accompanied by a fall in target returns, as well as a rise in the proportion of longer-term vehicles versus ten-year private equity-type fund models. The median net IRR being targeted by funds raising capital in 2021 was 8%, down from 9% five years before.

Impact real estate

Bfinance said the fee quotes in impact real estate were extremely diverse, reflecting the range of strategies that straddle core to value-add profiles, though the study saw some base fee clustering around the 100bps and 65bps levels. It said core strategies tend to be cheaper with no performance fees, while all value-add strategies have some form of a performance fee. For some managers, the performance fee relates to both financial and impact objectives, while for others it is purely financially focused.

Return targets were also very diverse and are not particularly strongly correlated with quoted fee levels. Managers in this sector seem unsure about how to price, and investors are unsure about what return expectations are appropriate and realistic. Bfinance said this diversity can, however, be helpful for investors that are keen to ensure that they do not overpay. The large number of start-up funds in the space and the low transparency around pricing can give well-informed clients a strong hand in negotiations.