Sin seems to be its own reward

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“Investments in unethical stocks, industries and countries have tended to outperform. For those for whom principles have a price, it is important to know the likely impact screening may have on both performance and diversification.”

While the implications may be a matter of conscience, the data is pretty clear.

Over 81 years covered in an earlier study (pages.stern.nyu.edu/~sternfin/mkacperc/public_html/sin.pdf), U.S. sin stocks (tobacco, gambling, alcohol) produced annualized excess returns of three to four percentage points a year. From 1985-2006 international sin stocks beat the market by roughly 250 basis points a year.

Buying stocks selected on ethical grounds may not lead to similar outperformance. The Vanguard FTSE Social Index Fund has underperformed the S&P 500 by about nine percentage points cumulatively since 2000. The social index fund tracks the FTSE 4Good US Select Index, which excludes the big three sin sectors as well as nuclear power, weapons and adult entertainment, as well as screening companies for inclusion on environmental, human rights, health and safety, labor standards and diversity criteria.

CORRUPTION PAYS, BUT FOR WHOM?

As for country selection, here as well you might want to shake hands with the devil, at least if wealth is your only objective.

Grouping countries into four buckets based on their World Bank control of corruption scores, there was a strong outperformance 2001-14 among stocks from countries with more graft. The 14 countries with ‘poor’ scores returned 11 percent annually in dollar terms, while the 11 ‘excellent’ countries returned 7.4 percent. Corruption may inhibit growth but it is just possible there exists a tacit deal to cut the providers of capital in on a share. Everyone else suffers, of course.

Another irony, when it comes to individual companies, is that the more attention the rest of the market pays to ethical considerations the better theoretically will be the returns to investors who either disagree with the basis of the considerations or ignore them and happily buy ‘sin’ stocks. That’s because, the market being a voting machine, a large movement of concerned investors out of a sector will drive down valuations. Low valuations, i.e. being able to buy an asset cheaply, imply better longer-term returns.

Given that investors with $45 trillion, about half of all global institutional money, are signatories to the UN-supported Principles for Responsible Investment charter, this effect may be large.

The traditional logic among ethical investors is that they can slow or end an industry by starving it of capital. Should an industry find it difficult or impossible to raise capital, growth can be slowed or the business become untenable. That is theoretically possible, but historical examples are hard to find.

More likely to have an impact are laws and regulations governing if and how a company selling a controversial product can do business. While the numbers on sin stocks are clear, a good deal of money among brewery and distillery investors would have been lost by the imposition of Prohibition in 1920.

Gambling stocks face similar risks, both from regulation, which might hit revenues, and deregulation, which may increase competition. If Internet gambling is deregulated in the U.S., the sunk costs of physical casinos will be just that, sunk.

You pay your money, you examine your conscience and you take your chances.

(At the time of publication James Saft did not own any directinvestments in securities mentioned in this article. He may bean owner indirectly as an investor in a fund. You can email himat jamessaft@jamessaft.com and find more columns at blogs.reuters.com/james-saft)

(Editing by James Dalgleish)