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While the cost of retail investments continues to decline, investors must be alert to the significant impacts of both product costs and inflation on their returns, according to research from the European Securities and Markets Authority (ESMA).

The regulator’s latest annual review found that investors in traditional investment funds paid about €2,000 in costs over 10 years on an initial €10,000 investment.

Market returns resulted in an average net value of €14,850 for these investments over the period — and the net real value, after accounting for inflation, was €13,500.

“Retail investors need to adapt to the high inflation environment and to anticipate the consequences on the real value of their investment and their savings,” ESMA’s report said.

The regulator’s research also found that ESG funds underperformed their non-ESG counterparts on average in 2022, even as their costs were lower.

This underperformance was likely due to high energy prices in 2022, it noted, adding that ESG funds continued to outperform their non-ESG equivalents over a three-year period.

“Costs and performance are key determinants of whether retail investors benefit from their investments, and whilst it is to be welcomed that the cost incurred by investors has slowly declined, retail investors still need to consider costs carefully in their investment decisions,” said Verena Ross, chair of ESMA, in a release.

“In 2022, investors were faced with a difficult environment characterized by lower returns and elevated level of inflation, accentuating the importance of the level of costs,” she added.

In the alternative fund sector, retail investors (which only account for about 14% of assets) also faced tough outcomes, the report suggested.

Retail investors invested primarily in funds of funds, “other” alt funds and real estate funds, it said — noting that real estate funds were the only category of the three with positive gross and net returns in 2022.

Alt fund returns were impacted by high inflation, rising interest rates and mounting economic growth concerns, ESMA noted.

And, given that real estate markets have faced “significant challenges” this year amid the ongoing rise in interest rates, this is likely to affect the future performance of real estate funds, it said.

Investment costs for structured retail products, which are largely charged as front-end fees, rose for most product types and issuers, the report said.

Additionally, the report said that an analysis of performance scenarios showed that returns would be negative for one out of eight structured products, “even in a moderate scenario.”