Better governance, better risk-adjusted after-tax returns, better member retention and, ultimately, better retirement incomes. These are some of the key benefits that behavioural finance can potentially deliver to major super funds and their members.
Insights from behavioural finance and the related decision-sciences have broad application across a major super fund’s teams and functions. When funds apply these insights systematically they can create significant quantifiable improvements to member outcomes. This article outlines some of the key applications of behavioural finance for major super funds and how to measure the benefits for funds and their members.
Improved fund governance
Behavioural finance is relevant for trustee boards and investment committees. For example, the empirical evidence related to effective group decision-making provides an evidence base from which the fund can determine how best to capture the benefits of diversity and independence.
In some ways outcomes from more effective governance are measurable. Board processes that systematically capture decision-making data can determine whether the team arrives at better decisions than the individuals it comprises – something that is more often assumed than is warranted by the evidence. Surveys of trustees can also track less tangible (but still important) measures that correlate with effective group decision-making, such as whether trustees feel their views are being heard and their perspectives and contributions valued.
Senior leadership teams can also set the context for effective decision-making throughout the fund. By fostering a culture in which constructive challenge is accepted and encouraged, and both learning from mistakes and evidence-based decision-making are valued, funds can establish the pre-conditions for both effective decision-making and innovation.
Better investment outcomes
Behavioural finance is also directly relevant for a fund’s investment decision-makers and the performance analytics teams that support them. For example, behavioural finance insights can assist these teams to identify and influence effective corporate decision-making in the companies in which major super funds can sometimes be significant shareholders. Alternatively, analytics that identify common decision-making patterns in the fund’s internal investment decisions – the types of patterns commonly found in academic behavioural finance research but rarely measured in practice – create opportunities to tweak and optimise internal investment processes.
Where funds outsource asset management, behavioural finance insights can help with manager selection. For example, by asking the right questions and seeking confirmatory data, funds can identify the managers who can demonstrate (rather than merely state) that they can overcome their own decision-making biases in their investment processes. The super funds that employ these insights can have more confidence that the historical outperformance these managers might have generated is, in fact, sustainable.
Improved investment outcomes that flow directly from a behavioural analysis can be measured in several ways, depending on the types of decisions being made and their consequences. They can sometimes be measured in terms of the inefficient taxes and costs that can be avoided, or in the additional returns that flow from systematically improved individual investment, asset class or fund manager selection decisions.
Better member engagement and member decision-making
Arguably, improved investment performance is meaningless unless it ultimately translates into better incomes for members in retirement. A key intervening factor in the translation from returns to incomes is the behaviour of the members themselves. Here too behavioural finance can assist.
Behavioural finance can assist super funds’ marketing, digital, data insights, communications and advice teams to better influence member behaviour. For example, behavioural insights can be employed to influence members towards making additional contributions, or to choosing an appropriate asset allocation, or to simply sticking with it across the investment cycle. Small changes in the way communications or choices are framed, whether it be face-to-face, over the phone or online, can often influence members’ decisions in ways that can significantly improve their retirement outcomes.
Behavioural finance can also be used to help with member engagement, commitment and retention. This can be critical at trigger points such as when members change employer, or for members considering the costs and benefits of SMSFs.
Product teams sit at the interface of some of the behavioural finance-related strategies. These teams can employ behavioural finance insights to design products that both incorporate effective investment decisions and align with member behaviours.
With funds increasingly obtaining more sophisticated and integrated member data and tools, many of the benefits of behavioural strategies can now be measured and tracked. Members might not know they have been influenced, but the funds that track their behaviour will be able to tell by how much they have benefited.
How can funds capture these benefits?
Team training on behavioural finance is often a good starting point – ensuring that all of the members of a board of trustees, investment or marketing team are aware of the relevant behavioural finance research, its implications and applications. Some funds might also benefit from specialist input into specific projects (eg product design, member campaigns, a review of investment governance or performance analytics). While no two funds or their member bases are identical, any fund that has professionals making decisions on behalf of members, or members making decisions on their own behalf, can potentially benefit.
For more information about how behavioural finance can help you see my recent book (Applying Behavioural Finance in Australia) or send me an email.
Simon Russell is the director of Behavioural Finance Australia.