But on the question of how passive investors can influence companies if they cannot divest from them, as long as they are in the index, the answer is engagement.
Engagement is time and resources consuming, but as long-term holders, passive funds have a strong vested interest in making sure that companies are managed correctly. After all, a company that is well managed should see its valuation rise. This will benefit investors and passive fund providers alike.
Given the low fees that passive funds charge, it’s clear that the higher the AUM in passive funds, the higher the total fee revenue stream. So even if one only does it for the sake of profits, passive fund sponsors have a very strong vested interest in ensuring that the companies they invest in are well managed.
FTA: More bespoke passive (ie ESG) funds tend to be pricier than standard passive funds. How do you see this change in future?
JGZ: It can be argued that there may be an incremental cost to building ESG benchmarks as you’d need extra research, for example in the shape of ESG ratings and data that needs to be paid for.
Meanwhile, as per the actual management of an ESG versus a mainstream passive, I don’t see that there are crucial differences that would justify a higher fee. So in the end, I guess that the main factor behind any fee premium between mainstream and ESG passive funds is likely to be index licensing costs.
I'd say, however, that when passive fund providers started launching ESG funds a few years back, the fee premium versus plain vanilla was more prominent than it is now.
The fee gap has been shrinking and it's not difficult to envisage an environment where both ESG and mainstream are priced equally. In fact, some of the ESG passive funds launched nowadays are cheaper than legacy mainstream peers.
FTA: Since about 2014 the price of passive investing has fallen steadily. Is there a limit as to how low prices can go?
JGZ: Well, in the US there are zero-fee ETFs. So, I guess that's the answer. But let's not be fooled by a zero-management fee.
Some of these zero-fee ETFs in the US were launched as marketing gimmicks and haven't really attracted much interest. It’s a cliché, but there's no such thing as a free lunch.
