Can super investors really bank on ethical investment?

A proportion of investors want to avoid controversial asset classes - but would it pay off?

One quarter of Australians would be willing to switch superannuation funds to avoid investing in coal or coal seam gas, according to a recent survey.

Not only does this research raise important questions about the coal/coal seam gas industry’s social licence to operate, it poses new questions about the level of demand for ethical superannuation.

The research, commissioned by Market Forces, a Friends of the Earth initiative, showed investor willingness to shift funds away from coal-based industries is spread relatively evenly across age and income groups.

So, is there a groundswell of investors willing to put their retirement cash where their personal values are?

A broader 2008 survey found that about half of respondents were concerned about their superannuation fund’s attempts to address climate change through investment decisions. Viewed alongside these most recent survey results, the findings suggest that there is a steady pattern of public concern. But public action does not appear to be escalating when it comes to changing superannuation funds to reflect individuals' environmental ideals.

The commissioning of the survey in the first instance does, however, reflect the growth of organised campaigns for ethical or socially responsible investment (SRI), including by groups like Asset Owners Disclosure Project and the Climate Institute.

SRI is an extremely tricky area for both investors and superannuation funds trying to “do the right thing”.

For investors, choosing to have their funds redirected from investment in companies whose activities they cannot morally or ethically abide– whether it be coal/CSG, tobacco, sweatshops, gambling or guns – provides a means to ensure guilt-free sunset years. No one wants to upholster the campervan with retirement funds derived from child labour.

For super funds, SRI raises complex questions about investor returns. Fund managers bear the great responsibility of ensuring their members receive the best return on investments to secure a good retirement. Many of Australia’s leading superannuation funds approach optimal investor return as a moral duty. They see the financial security of Australians as an obligation.

Analysts disagree on whether investment portfolios defined by socially and ethically responsible principles achieve returns equivalent to portfolios without these criteria. A recent US study found “sinful” investors to be outperforming their angelic counterparts, comparing VICE (e.g. funds invested in alcohol, tobacco, gambling and guns) and SRI indices over the long-term. But other researchers argue that socially responsible companies will ultimately outperform their naughty counterparts whose stock prices will eventually be dragged down by the weight of scandal, financial misbehaviour or government censure. Even more recently, the Australian Financial Review (paywalled) reported that, since their inception 20 years ago, SRI indices perform about the same as the traditional market.

How then, do superannuation investment managers balance their obligation for greatest return on investment with individual members’ personal values? Perhaps the even more difficult question is, should this be the funds’ concern?

To a degree, improvements in active investor management, especially through the offering of specialised portfolios or ethical funds, is helping to respond to this challenge. By allowing members themselves to choose investment options based on personal beliefs and preferences, superannuation funds maintain their commitment to best retirement outcomes, while devolving decisions about types of investment — and consequent levels of return — directly to the consumer.

But member disengagement with their super funds is a widely recognised concern. Despite the recent survey results, most superannuation members are unlikely to change funds or lobby for climate sensitive investment criteria. For the majority of their members, fund managers must interpret and act on the market on behalf of investors who may not understand their choices nor care about their decision-making processes.

Many funds promote financial literacy programs in an effort to encourage greater investor involvement with their funds. But studies show that members’ financial literacy remains low. Faced with overwhelming choices in a market they cannot read, investors show little interest in understanding net present value (NPV) or deciphering earnings before interest, taxes, depreciation and amortisation (EBITDA).

Many Australian super funds are taking their own positions against climate change within this conflicted investment space. Several major funds are members of the Investor Group on Climate Change which urges funds to consider climate change-related risks and opportunities for climate change mitigation when making investment decisions.

The voluntary United Nations’ Principles for Responsible Investment provide further guidance for signatory super funds. The first principle commits signatories to “incorporate environmental, social and governance issues into investment analysis and decision-making processes”.

A growing number of Australian super funds are also being guided by sustainability reporting, with the widely used Global Reporting Initiative asking fund managers to report on screening for environmental and social risks in their portfolios.

Shareholders and investors hold significant power to influence corporate behaviour. This power is negligible, however, without direct investor action. Meanwhile, many superannuation funds will continue to implement decision-making which balances member returns with social and environmental concerns. But real action against climate change requires individual investors to become better engaged.