(Bloomberg) -- Ethical fund managers don’t have to be envious of the market-beating returns of so-called sin stocks. They should be able to match them without dabbling in vice, according to a study in the Fall edition of the Journal of Portfolio Management.
The study debunks the popular theory that shares in the alcohol, tobacco, gaming, and weapons industries outperform because investors shun them, enabling those with fewer moral scruples to earn a “reputation risk premium.”
In fact any outperformance is a factor of the profitability of companies in the “sin” industries and the extent of their investments, the authors found. Investors can emulate those returns by looking for similar qualities in more straight-laced business sectors, they said.
“There is nothing mysterious about the performance of sin stocks,” authors David Blitz, Robeco Asset Management’s head of quantitative equity research, and Frank Fabozzi, professor in finance at EDHEC Business School in Nice, concluded. “It is exactly what one would expect based on their exposure to factors that are included in current asset-pricing models.”
The ISE SINdex Index, a gauge of “vice” shares including casinos, distillers and cigarette makers, has risen 26 percent this year, more than double the 11 percent gain in the S&P 500. The measure has climbed 124 percent over the last five years compared with 71 percent for the S&P 500, according to data compiled by Bloomberg.
Rather than fret about the ethics of investing in these companies, fund managers could avoid missing out on potential returns by putting their money into non-sin stocks that have exposure to the same factors that drive sin stock returns.
“Now that it is clear where this performance loss is coming from, it is also clear what investors may do about this,” the authors wrote.