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By Cecile Lefort
SYDNEY, Dec 17 (Reuters) - Increasingly controversial environmental issues in Australia and a global slump in commodity prices are putting pressure on Australia's A$1.8 trillion ($1.47 trillion) pension fund industry to adopt socially responsible investing policies - including a restriction on funding fossil fuels.
Ethical funds have grown to more than A$150 billion this year from just a couple of hundred million dollars a decade ago, the Responsible Investment Association told Reuters.
Funds run on ethical, socially responsible or sustainable principles attempt to invest only in companies that meet certain environmental and social standards and will typically not invest in companies exposed to sectors such as gambling, alcohol, weapons and tobacco.
The price fetched by Australian coal has fallen about 30 percent this year to $60 a tonne. With other commodity prices also in freefall, an ethical investing push could not come at a better time, with returns often giving traditional assets a vigorous run for their money.
Healthcare, clean technology, recycling and waste management were ethical funds' most-favoured sectors due to their stable economic profile.
"As mining continues to perform poorly, any fund not exposed to resources will outperform," said Tim Murphy, co-head of fund research at Morningstar.
Climate change issues have often stirred intense political controversy in Australia, which is a major exporter of coal, and also ranks as one of the world's biggest carbon emitters per person.
Earlier this year, the Australian senate voted to scrap a controversial carbon tax in a major victory for the pro-coal, pro-logging government, and Prime Minister Tony Abbott who crusaded against the tax in his 2013 election campaign.
But Abbott then surprised many this month by pledging A$200 million for a United Nations climate fund, a major policy reversal for the embattled climate-change sceptic, who was embarrassed by U.S. President Barack Obama's criticism of Australia's treatment of the Great Barrier Reef, an example of the environmentalist pressure to which even pro-carbon politicians sometimes succumb.
But cold-shouldering fossil fuels in a country where coal is the second-largest export earner and the biggest source of energy risks harming pension fund members themselves, even as it seeks to help the environment.
"It is difficult to tell a (fund) member who works in the electricity or coal industry that we are not going to invest in fossil fuels anymore and it could also mean losing his or her job," said Nick Vamvakas, executive risk officer at fund manager Equipsuper.
"Therefore, you have to be sensitive to all the factors going into making decisions around ethical investing," he said.
Equipsuper manages A$7 billion in pension funds, locally known as superannuation or "super" funds, which make up the national mandatory retirement savings scheme.
Vamvakas, who is developing an ethical investment policy and following in the steps of rival funds including VicSuper, Hesta and CBus, is not alone facing such an asset allocation quandary.
Asset managers also have to deal with illiquidity and concentration risks that come with restricted investment options in a fairly narrow-focused economy.
"It is particularly acute in Australia because a large part of the market capitalisation is exposed to coal," said Andrew Gray, investment manager for governance at AustralianSuper, which manages A$80 billion. A quarter of the country's top-200 listed companies are related to fossil fuels.
Yet, data shows that when it comes to returns, responsible investing can deliver better returns than one may suspect.
According to research firm SuperRatings, responsible investments in Australian shares were the clear outperformer, delivering 30.6 percent over a three-year timeframe, versus 26.8 percent from a "standard" pool of local equities.
Editing by Nachum Kaplan and Eric Meijer