Emotions can strongly influence your investment decisions. Interestingly, when you are in a bad mood, you are likely to invest in safer and sustainable funds, according to a study published in the journal Economics Letters.
Professors Alexandre Garel (Audencia Business School), Adrian Fernandez-Perez (Auckland University of Technology) and Ivan Indriawan (University of Adelaide) found in their research that pessimism and worse mood are associated with greater investment in sustainable assets.
Investors become more risk-averse when they are in a lower mood. So when they are sad, depressed or angry, they are likely to be more cautious while making investment decisions and choose investments with lower risks, according to the study.
“In our paper, we examine the relationship between investor mood and the demand for sustainable investments. Our measure of the demand for sustainable investments is the inflows to sustainable mutual funds. We capture the average mood of investors using the prevalence of seasonal affective disorders. We find that worse mood is associated with greater inflows to sustainable funds, which is consistent with greater risk aversion pushing investors to favour sustainable funds that they perceive as less risky,” Professor Alexandre Garel told FE.com via email.
“More broadly, our study speaks to the role of emotions in investment decision making and in shaping market outcomes (like the performance of sustainable funds). Emotions are more likely to affect market outcomes when the importance of retail investors is greater or there are higher limits to arbitrage,” he added.
Isn’t it bad that low mood is linked to sustainable investment?
The scholars’ first intuition was that a good mood should be associated with more inflows to sustainable funds. However, the study documented the opposite.
“Our first intuition was that good mood, if anything, should be associated with more inflows to sustainable funds. This is because prior literature shows that a positive mood promotes prosocial behaviors and altruistic values. This could apply to sustainable investments because they benefit other parties than the investor (i.e., community, employees, environment),” said Professor Garel.
“However, we document the opposite. That is, when the average mood deteriorates in a country, we observe greater inflows to sustainable funds relative to other funds,” he added.
According to the professor, the finding of the study is consistent with a risk-aversion explanation according to which, when mood deteriorates, investors become more risk averse, and hence favour sustainable funds that they perceive as less risky.
“There are good reasons to think that investors perceive sustainable funds as less risky. The stocks in such funds have been shown to better weather financial crises and companies with top environmental and social practices should be less exposed to the growing environmental and social risks attached to, among others, polluting, not doing the energy transition, not addressing diversity issues, or mistreating employees,” he said.
Should one let emotions drive investment decisions?
Professor Garel suggested one should follow stringent investment rules instead of getting driven by emotions.
“Two elements here. First, retail investors need to be aware that emotions can influence their trading behaviour, for instance making them too optimistic in their forecasts. Second, because one cannot be a cold-blooded rational investor all the time, putting in place stringent investment rules, using more collaborative decision making, or sticking to the facts, can prevent individual emotions to overly influence investment decisions,” he said.
What are the key takeaways from this research for investors in India?
Because India is not in our sample (due to sustainable fund data availability), we cannot say whether the results we obtain based on an international sample of 25 countries also apply to this country, the Professor said.