There may be a less-than-virtuous reason to consider ethical superannuation investments, according to a US academic.

Australians may or may not have any qualms about investing in cigarettes, gambling, coal, weapons and slave labour. But a trick of brain psychology could make divestment from companies involved in these ‘unethical’ practices a smart money move.

There is currently a trend towards ethical investments in super funds, as well as other parts of the financial sector. It is driven by concerns about the environment, human rights and other issues of morality. But it could also have a nice pay-off.

That’s because, according to retirement expert Dr Michael Finke at Texas Tech University, ethical investments could be a way to overcome the parts of our brain that act in financially irrational ways.

“In my own research, I find that investors become predictably more risk averse after markets fall. This often leads them to sell stocks when prices are lowest, which results in significant mutual fund investor underperformance of about 1.5 per cent per year,” Dr Finke told The New Daily.

Australian super funds are similar to their US mutual fund cousins. The main difference is that US citizens can pull out their money entirely (as they often do after a market crash), whereas Australians can only move their retirement savings between funds.

Dr Finke says emotional attachment is an important factor.

The research may be relevant to the Australian context because of the “emotional attachment” factor that Dr Finke observed, which could be universal.

“A client who feels an emotional attachment to the mission of a socially responsible mutual fund may be able to reinterpret the investment as a long-run goal,” he said.

“Shifting the frame of reference to the long run helps investors stay the course and ultimately may lead to better actual long-run performance even if the socially responsible [fund] isn’t keeping up with the market.”

‘A gateway to deeper engagement’

An analogy Dr Finke has used in the past is a person riding an elephant. The irrational part of the human brain is huge and unwieldy, much like an elephant, with the rational side perched on top like a rider. If the elephant decides to rampage through a local village (or get spooked by stock market fluctuations or ignore retirement savings), there’s not much the rider can do.

For many Australians, the elephant of irrationality is in charge of their retirement. Photo: Getty

If we accept, as research tells us, that many Australians don’t think about retirement, put aside extra money early enough, examine fund management fees, consolidate multiple accounts or select the most prudent risk ratios, then it would seem the elephant is in charge – no matter how often experts warn us of the dire consequences.

Responsible Investment Association Australasia (RIAA) chief executive Simon O’Connor agreed that ethical investing could be a useful strategy to combat this lack of engagement.

“What we’re currently seeing is something of an awakening by consumers that their retirement savings can be put to work to drive strong financial outcomes, as well as contributing to a better society and environment,” Mr O’Connor told The New Daily.

“When consumers and the public understand this, then I think this is a great gateway to get them much more deeply engaged with an area that we know is very tricky to get the public engaged with.”

Better returns too?

There does indeed seem to be an “awakening” underway, as the RIAA’s Mr O’Connor observed.

The latest report from the RIAA, published in July, estimated that ‘core responsible’ investments (the most ethical classification) doubled across the financial sector, including super funds, from $25.6 billion in 2013 to $51.5 billion in 2015.

An example is AustralianSuper’s ‘Socially Aware‘ fund, opened on 30 May 2016, which avoids fossil fuels, tobacco, cluster munitions and landmines, companies with questionable track records on human rights and corporate governance, and ASX 200 companies with all male (or all female) boards.

Others are following. Phil Vernon, the boss of Australian Ethical, an ASX-listed retirement fund management company, recently pronounced that conscientious investing has “come of age”.

Nor would it seem that have ethical investors have missed out on returns. The RIAA’s report also calculated that Australian equities funds invested in ‘core responsible’ investment outperformed both the ASX300 and the average large cap Australian equities funds across one, three, five and 10 years.

The counterview

While the focus of ethical investing is often on shunning tobacco and other questionable industries, Mr O’Connor said there is more to it than just divesting.

The conundrum: shun ‘unethical’ investments or improve them through shareholder activism? Photo: Getty

“Equally important is those industries that are being supported through investment. There are a lot of strong stories of super funds, as large owners of certain companies, actually having direct engagement and conversations with those companies to improve their performance, to improve their societal and environmental impacts.”

Professor Paul Gerrans, a superannuation researcher at the University of Western Australia, also had his doubts. He said ethical investment options might drive engagement, but he would be “extremely surprised” if they encouraged additional contributions to super through salary sacrificing.

* The New Daily is owned by industry super funds.