Thursday, 19 September 2019

How Sin Stocks Work

How Sin Stocks Work
21 Jan
5:00

In 2018, sustainable, responsible and impact investing (SRI) assets accounted for $12 trillion — or one in every four dollars under professional management. SRI mutual funds and exchange-traded funds seek to profit on social good by omitting stocks of companies that fail to meet certain ethical, governance or sustainability standards.

However, among the ousted companies are well-run, profitable brands which will always have a bad reputation with some investors. These are sometimes known as sin stocks.

What are sin stocks?

Sin stocks are shares of companies that profit from goods or services promoting vice, including tobacco, alcohol, gambling and weapons.

Exactly what constitutes a sin stock is up to each investor’s opinion, of course. Some investors might add predatory lenders, for-profit prisons or nuclear power companies to the sinful category. Others may limit holdings of companies with large carbon footprints.

However, when investors talk sin stocks, they primarily mean investments in tobacco, alcohol, gambling and weapons — industries which fall into a category of consumer goods that can outperform when other stocks falter. This stands to reason: Consumers may cut spending on new clothes or gadgets during tough economic times, for example, but a smoke and a glass of wine can feel like a small, stress-relieving indulgence. Certainly, the addictive nature of these vices makes them non-discretionary for some consumers.

Are sin stocks good investments?

Sin stocks can be good investments, but they have their drawbacks, too. Here are a few possible benefits and disadvantages of this type of investment.

Pros

  • Vice returns can be nice returns. Some evidence suggests that sin stocks can produce higher than average returns. For example, the ISE Sindex Index (NASDAQ: SIN), which tracks sin stocks, had a five-year increase of roughly 42% in December 2018, compared to an 18% return from the S&P 500 Index.
  • Barriers to entry can be beneficial. Sin industries are often highly regulated, so there may not be a lot of new competition challenging well-known brands. For example, tobacco companies are restricted from advertising, which makes it difficult for small challenger brands to emerge.
  • “Shunning” could mean opportunities. Sin stocks are also called “shunned stocks” because some investors — including institutional investors such as mutual fund managers — shy away from them to keep shareholders happy. Investors looking for underpriced bargains may hunt in overlooked areas of the market like this.
  • Sin industries are designed for profitability. Shunning alone is not the reason for the success of sin stocks. In the 2017 paper Sin Stocks Revisited, equity research analyst David Blitz and finance professor Frank Fabozzi found this may be due to a successful combination of fixed asset pricing models and limits on new investments. These operational efficiencies could lead to greater profitability.

Cons

  • Owning them may make you feel guilty. If your investment decisions are driven or even swayed by moral beliefs or ethical values, there is much to dislike in this category. Investing in any sin stocks may weigh on your conscience.
  • Sin stocks have bear markets. While sin stocks may not perform like the rest of the market, they do have their boom and bust cycles. Gun stocks, for example, had been on the decline for nearly two years between 2016 and 2018, before rebounding in third-quarter 2018.
  • Some sin industries are untested. Marijuana is an example of a sin industry with great potential but no clear market leaders. The industry is still emerging, with legalization movements changing regulation around the country and the globe. It may be too early to tell which companies will become thriving well-managed businesses. Until then, investing in this area may be risky.

Should sin stocks be part of your portfolio?

If you aren’t averse to vice, being open to sin stocks could help boost your investment portfolio. Here are some ways to get exposure to these stocks, and what to consider before investing in each.

  • Index fund or ETF: Market index funds and index ETFs do not screen out stocks for ethical or any other reason, but simply provide broad exposure to certain markets. If you want some exposure to sin stocks without having to seek them out, you could get it through a broad-market index fund, such as a Standard &Poor’s 500 fund or ETF.
  • Actively managed fund: Those looking for a more niche approach may consider a managed mutual fund specializing in sin stocks, such as the Vice Fund (VICEX). At 1.49%, the fund’s expense ratio is higher than the 0.59% average for actively managed funds. But the fund has a 10-year total return of roughly 11%, compared to a -3.35% return in the Russell 1000 Index for the same period. Keep in mind, however, sin stocks are not an asset class. A fund as targeted as this may be overkill for the average investor portfolio.
  • Individual stocks: If you prefer to invest in individual stocks, research sin stocks as you would any other type of stock, by looking at the company’s financial health, growth, dividends, competition, challenges and more.

Not everyone has the stomach for sin. If you prefer to avoid sin stocks altogether, you may find a more virtuous proxy by researching stocks with the same types of profitability and investment profiles. Otherwise, consider indulging in a bit of sin once in a while. It could be just the thing your portfolio needs.

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Melissa Phipps

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Source: https://www.magnifymoney.com/blog/investing/sin-stocks-guide/

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