Investment objectives: are you max return or min risk?

David, I sort of agree with you - in a fund that has many investors like a super fund, the ethics of members are likely to be different and thus ethics is difficult to bring into the decision- making. Ethical funds struggle in the public offer space for that reason. I manage a very large ethical fund, but it's for one client (the Uniting Church) who defines the ethical principles that are to be implemented and is very happy with what's being excluded and what's being emphasised.

However, The ESG that most funds are looking at is not "ethical". Rather, it is an explicit recognition that environmental, social and governance factors create potential risks that it is prudent and appropriate to take into account. You don't have to believe, for example, that cheating on emissions tests for the sake of marketing your vehicles is wrong behaviour, but fund managers who saw governance risk at VW were ahead of the game in being out of or underweight that stock when the proverbial hit the fan. Why would you not want a fund to be thinking about such risks?

I wrote more about this in an article for cuffelinks last October, so won't go into more detail here on the different approaches to ESG, but would ask one question. Why do you think that ethical investment approaches have to underperform? Do you think that companies that cheat, or deceive or engage in activities that are harmful to people or the environment are going to be the best performers and that you'll miss out on great returns by not owning them? sure there are, for example, gambling companies that make money. But why do you think they will outperform the rest of the market? The evidence is fairly clear that they don't, except perhaps for brief periods. Well run unethical companies tend to return in line with the market over time at best.

At a more macro level, the ethical benchmark that we at Uniting Financial Services use has outperformed the ASX 200 and 300 over the past five years. That's not a sufficient bit of analysis to prove that ethical returns are better or worse, but it is supportive of the hypothesis that our exclusions don't underperform the rest of the market.

Some people point to poorly performed ethical funds, but the reality there is that it wasn't the ethics of their decisions that caused underperformance but poor stock picks within their universe - exactly the same as with funds that don't have ethical screens.

Therefore, institutional fund trustees who decide that it is appropriate to invest using ESG principles are not automatically creating an underperforming situation as you assert. They are seeking, rather, to invest with their eyes open and their prejudices locked away.

Ethical investing is all about irrational personal and ideological beliefs. It's mostly irrational and much of it is just plain wrong. For example, it is irrational and unethical to not support coal and uranium. Nuclear power is the safest way to generate electricity. Those who do not know this are misinformed. If not for 50 years of anti-nuke scaremongering, 4.5 million fatalities would have been avoided globally in the past 30 years. If not for fossil fuels, billions of lives would have been lost. If not for coal exports now and in the future, people will remain in poverty longer and tens of million more fatalities will occur as a result. This is what the irrational, unethical, immoral "ethical investors" are achieving.

Raewyn Williams and Cuffelinks,

Thank you for this very relevant and important article.

I have a problem with this and other articles on portfolio risk management for SMSFs. My problem is with how the term "Risk" is used. I interpret 'risk' is being used here as a measure of volatility. However, I think that is a misleading and incorrect use for SMSF portfolio risk management. Risk is consequences multiplied by probability the consequence will occur. I suggest the consequence is that the SMSF will run out of money before the members die or the annual pension amounts will be insufficent to maintain the standard of living the members expected.

I like to view probability distribution charts of the the portfolio balance and of the annual pension amounts through to age 100 years with different mixes of portfolio asset classes. These use long ther historical returns data, such as from the well known Andex data (e.g. the Vanguard Charts), Bralisford's data for Australia since 1983, etc. Data specific to the SMSF members is input.

Volatility is not my primary conccern. My primary concern is that the SMSF will be able to pay the real value of our current pensions until we die. Since we don't know when we will die, I wan to plan for the SMSF to continue topay the current real value of our penstion to age 100. Are there free or low cost products available that can do this?

Peter,

Surely you exaggerate (or jest) when you describe ethical beliefs as irrational personal ideological and ultimately immoral.

All human beliefs are personal, and in a given framework, rational. Thus, minimising animal cruelty while eating them, not supporting oppressive child labour, eschewing bonded or slave workers, dominating the vulnerable because one can - might be irrational nonsense for those who perpetrate them, but not if you are the at the receiving end.

As we have evolved, our framework has too, thus making past practices no longer acceptable.

Where people are free to think, this includes the freedom to think what others consider irrational (e.g., religions). In investments, just go with what closely aligns with your own (irrational) beliefs. If no such vehicle is available, create one.

Ramani,

Do you believe it is ethical to support policies and investment decisions that cause large numbers of premature fatalities per year?

Policies that inhibit cheap electricity generation are doing just that. Anti-nuclear activists and policies have caused 5 million or more premature fatalities globally in the past 30 years. Anti-coal policies are retarding the rate people are lifted out of poverty. Most rational people would consider such policies to be unethical if they understood the consequences of them. The people who advocate for such policies are mostly either ignorant the real effects, gullible and/or ideologues.

Peter, I do not believe in selectively attributing incidental outcomes to well-meaning people driven by conviction, any more than I would sheet home electrocution deaths (accidental as well as US style justice) to those who advocate its day to day merits. We do not hold coal lobbyists for coal-related lung diseases, however causative.

In the extreme, you could hold parents bringing kids to the world responsible for their eventual death on the 'but for' argumentation. Normal society does not work this way.

If the Amish avoid modern contraptions, or monks live by self-inflicted poverty, that is their fringe choice. Not immoral nor unethical, in my book.