Illustration: Sarah Grillo/Axios

Investors are pouring record amounts of money into passive ESG funds — but the vagueness of just how money managers determine the makeup of their sustainable funds is now attracting attention from regulators.

Why it matters: Investors are paying high management fees for these "socially responsible" funds. It's important that they get what they pay for.

By the numbers: The average expense ratio, or how much companies charge to manage an exchange-traded fund, for ESGs is 0.42%, according to ETF.com.

  • Compare that to the average expense ratio of 0.15% for non-ESG passive funds last year, with a growing number of ETFs having no management fees at all.
  • Sustainable funds have seen record net flows this year, but it still pales in comparison to ETF total net flows.
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Data: Morningstar Direct; Chart: Andrew Witherspoon/Axios

Driving the news: The SEC is reportedly examining "advisers' criteria for determining an investment to be socially responsible and their methodology for applying those criteria and making investments," per the Wall Street Journal.

  • SEC examiners — which can offer recommendations to the regulators' enforcement arm — sent an undisclosed number of letters inquiring about firms' stock-selection methodology, as well as their proxy voting records with respect to ESG issues.

Context: There still aren't any specific definitions or standards for "ESG" in the U.S.

  • That means ESG funds can get away with investing in oil and gas giants, as the WSJ reported — though those companies are often targets of social activists.
  • It also means that funds dedicated to investing in companies with women on boards can vote against gender and diversity shareholder proposals without losing its self-appointed ESG status.

Meanwhile, EU lawmakers today took the “first step for establishing a framework“ for a system that determined which investments could be called ”green” or ”sustainable,” Reuters reports.

Felix’s thought bubble: ESG fund managers have had no incentive to complain in public about competitors that don't live up to their marketing materials. No one wants to be the person saying that the asset class is problematic.

  • But now that significant money is flowing into ESG funds, the SEC looks as though it's inclined to impose some much-needed discipline.

The bottom line: Industry wonks have voiced concern about potential issues of the opacity of the asset class — but the SEC's reported interest is going to be taken much more seriously by ETF managers.

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