By Ron Robins
The stock market plunge in 2008 changed investment returns and investor consciousness in many ways. Prior to 2008, many investment studies found ’sin’ stock portfolios providing better returns than ethically or conventionally oriented ones. Since then however, there is preliminary evidence that ethical stock portfolios have probably performed better. Over the next five to ten years, and with the effects of the sovereign debt crises upon us, I suspect that ethical stock portfolios could outperform both the sin and conventional variety.
Sin stock portfolios generally include holdings in tobacco, alcohol, gaming and defence companies. Ethical or socially responsible (SR) portfolios on the other hand typically comprise of stocks in companies related to the financial, technology, medical/health, alternative energy, consumer staples industries etc. However, with the growing focus on environmental, social, governance (ESG) and ethical issues, ethical/SR portfolios are becoming increasingly diverse.
American supporters of sin stock investing like to quote a February study, “Socially Responsible Investing vs. Vice Investing,” by Hoje Jo et al. It compares the Vice (sin) Fund (VICEX) and Domini SR funds. It stated, “our research shows while the annualized return of SRI [socially responsible investing] through Domini Social Index (DS 400 Index) from 1990 to 2009 has been higher than that of S&P 500 â€¦[and the] Domini Social Equity Mutual Fund (DSEFX) outperformed vice investing through vice fund (VICEX) over the most recent one year, VICEX has outperformed DSEFX over the long term.”
Incidentally, in the twelve months ended June 30, 2010, the DSEFX continued to lead with a gain of 16.81 per cent, outpacing the VICEX′s gain of 7.73 per cent. It is also worthwhile to consider the time period of this ‘long term′ study: seven years. It begins with the inception of the Vice Fund in 2002. Generally, long term performance is better analyzed over ten, fifteen, or more years′ time frame. Also, comparing two funds in a universe of thousands, though probably representative of the chosen criteria, does pose a question of statistical significance.
From a European perspective, one outstanding 2009 German study with excellent methodology is, “Vice vs. Virtue Investing,” by Sebastion Lobe, Stefan Roithmeier and Christian Walkshausl. It clearly indicates no difference in returns between ethical and ‘unethical′ portfolios. I quote, “we find no compelling evidence that ethical and unethical screens lead to a significant difference in their financial performance, which is in contrast with the results of prior studies on sinful investing.”
Another 2007 French study finds fault with the idea that sin stock portfolios perform similarly in all countries. In “The Determinants of Sin Stock Returns: Evidence on the European Market,” by Julie Salaber, she states that, “ â€¦sin stock returns vary with the level of excise taxation on alcohol and tobacco products. Sin stocks earn significantly higher abnormal returns in countries where the excise taxation is highâ€¦ average sin stock returns depend on country-specific factors such as religion, litigation risk and excise taxation.”
Incidentally, a comprehensive listing of studies related to ethical/SR and sin investing can be found on my website.
Proponents of sin industry investing say that many ethical/SR funds often have higher annual management fees, thereby decreasing returns. Also, that fund managers and analysts avoid sin industries. Because of this sin industry stocks are relatively cheap. And due to their enormous, regular cash flows they are able to make large dividend payouts. These big dividends combined with low stock prices frequently provide exceptionally good dividend yields.
Thus, sin stock proponents argue that when looking at stock returns you also have to consider not only stock price appreciation or losses, but also the ‘total return′ which is inclusive of dividends. These are valid points that are not accounted for in many studies which only measure stock/fund price changes.
However, the often high dividend yields of sin investments are shunned by numerous investors as they are concerned about the effects of sin industries on the quality of life for themselves, their families and for society as a whole. However, that discussion is for another day.
There is a major new factor impacting our quality of life and the sin versus ethical investing debate. This is the massive sovereign debt crises.
Countries like the United States, Britain, Japan and many others face enormous unfunded health and pension liabilities. The pressure for those countries to increase taxation on goods such as tobacco and alcohol that contribute disproportionately to health costs is going to be immense. Furthermore, it is likely that government outlays for defence will be reduced too. The gaming industries could meet increased taxation as well. Therefore, sin industry profits would be squeezed. So present day investors in sin industries may see their returns suffer due to government austerity programmes.
The year 2008 was a game changing event for investors. It saw the demise of excesses and brought about a new consciousness. This new investor consciousness engages environmental, social, governance and ethical concerns, while governments preach austerity and consider new taxes on our vices. Future investment returns may well favour ethical over sin investing.
July 13, 2010