09-11-2017 · Research

Research reveals why sin stocks outperform

The mystery of sin stocks’ outperformance has finally been unraveled.

Companies selling alcohol or cigarettes among other human vices have historically enjoyed higher returns than the stock market indices to which they belong. Ironically, the stocks of tobacco companies have at times performed better than the pharma companies making cancer drugs to combat smoking-related illnesses.

Since all active fund managers chase alpha – seeking to make higher returns than the benchmark – this in theory makes them ideal holdings. However, investors holding them can face reputational risk, particularly as lobbyists become increasingly vocal against industries known to harm human health such as alcohol or weapons.

So how come sin stocks outperform, making them irresistible but shunned at the same time? Their returns were investigated by David Blitz, co-head of quantitative research at Robeco, and Frank Fabozzi, Professor of Finance at EDHEC Business School, in their article ‘Sin Stocks Revisited: Resolving the Sin Stock Anomaly’ published in the Journal of Portfolio Management.

Smoking gun

Blitz and Fabozzi define sin stocks as companies directly involved in the alcohol, tobacco, gambling or weapons industries. Many are barred from portfolios on ethical grounds.

“Various studies have investigated the historical performance of sin stocks and observed that they have delivered significantly positive abnormal returns,” says Blitz. “Despite this, many investors have composed an exclusion list of sin stocks that they do not wish to invest in because they do not want to be associated with the activities of these firms.”

“A popular explanation for the observed abnormal returns of sin stocks is that they are systematically underpriced because so many investors shun them. This enables investors who are willing to invest in sin stocks, going against social norms, to earn a reputation risk premium. Other explanations are that sin industries could benefit from monopolistic returns, or that these stocks face increased litigation risk for which investors are rewarded.”

loader

Stay informed on our latest insights with monthly mail updates

Receive our Robeco newsletter and be the first to read the latest insights and build the greenest portfolio.

Stay updated

Quality factors

In fact, the outperformance of sin stocks can be explained by the two new quality factors in the recently introduced five-factor model by renowned economists Eugene Fama and Kenneth French, says Blitz. Their previous three-factor model used ‘market risk’, ‘size’ and ‘value’ to explain why some stocks performed better than others. The 2015 update added two quality factors, ‘profitability’ and ‘investment’.

The profitability factor maintains that stocks with a high operating profitability perform better, while the investment factor suggests that companies with high total asset growth perform worse. Sin stocks tend to have high exposure to both factors; cigarette makers, for example, enjoy high margins due to relative price inelasticity, and are restricted in how they can grow their assets.

Blitz and Fabozzi re-examined the performance of sin stocks using global data right up until the end of 2016, focusing on the question of how their performance holds up in light of these latest factor theory insights.

Mystery explained

“We find that, consistent with the existing literature, sin stocks exhibit a significant outperformance in the US, European, and global samples,” says Blitz. “However, this premium disappears completely when accounting not only for classic factors such as size, value, and momentum, but also for exposures to the two new Fama-French quality factors – profitability and investment.”

“For Japan, sin stocks also exhibit significant exposures to the profitability and investment factors. In sum, the performance of sin stocks is fully in line with their exposures to factors included in current asset pricing models, and there is no evidence of a specific sin premium next to that.”

It means that investors who are uncomfortable holding sin stocks but don’t want to miss out on outperformance can proxy them by weighting their portfolios towards the Fama-French factors including profitability and investment.

Download the publication

Let's keep the conversation going

Keep track of fast-moving events in sustainable and quantitative investing, trends and credits with our newsletters.

Stay updated
Robeco

Robeco aims to enable its clients to achieve their financial and sustainability goals by providing superior investment returns and solutions.

Important information
The Robeco Capital Growth Funds have not been registered under the United States Investment Company Act of 1940, as amended, nor or the United States Securities Act of 1933, as amended. None of the shares may be offered or sold, directly or indirectly in the United States or to any U.S. Person (within the meaning of Regulation S promulgated under the Securities Act of 1933, as amended (the “Securities Act”)). Furthermore, Robeco Institutional Asset Management B.V. (Robeco) does not provide investment advisory services, or hold itself out as providing investment advisory services, in the United States or to any U.S. Person (within the meaning of Regulation S promulgated under the Securities Act).
This website is intended for use only by non-U.S. Persons outside of the United States (within the meaning of Regulation S promulgated under the Securities Act who are professional investors, or professional fiduciaries representing such non-U.S. Person investors. By clicking “I Agree” on our website disclaimer and accessing the information on this website, including any subdomain thereof, you are certifying and agreeing to the following: (i) you have read, understood and agree to this disclaimer, (ii) you have informed yourself of any applicable legal restrictions and represent that by accessing the information contained on this website, you are not in violation of, and will not be causing Robeco or any of its affiliated entities or issuers to violate, any applicable laws and, as a result, you are legally authorized to access such information on behalf of yourself and any underlying investment advisory client, (iii) you understand and acknowledge that certain information presented herein relates to securities that have not been registered under the Securities Act, and may be offered or sold only outside the United States and only to, or for the account or benefit of, non-U.S. Persons (within the meaning of Regulation S under the Securities Act), (iv) you are, or are a discretionary investment adviser representing, a non-U.S. Person (within the meaning of Regulation S under the Securities Act) located outside of the United States and (v) you are, or are a discretionary investment adviser representing, a professional non-retail investor.


Access to this website has been limited so that it shall not constitute directed selling efforts (as defined in Regulation S under the Securities Act) in the United States and so that it shall not be deemed to constitute Robeco holding itself out generally to the public in the U.S. as an investment adviser. Nothing contained herein constitutes an offer to sell securities or solicitation of an offer to purchase any securities in any jurisdiction. We reserve the right to deny access to any visitor, including, but not limited to, those visitors with IP addresses residing in the United States. This website has been carefully prepared by Robeco. The information contained in this publication is based upon sources of information believed to be reliable. Robeco is not answerable for the accuracy or completeness of the facts, opinions, expectations and results referred to therein. Whilst every care has been taken in the preparation of this website, we do not accept any responsibility for damage of any kind resulting from incorrect or incomplete information. This website is subject to change without notice. The value of the investments may fluctuate. Past performance is no guarantee of future results. If the currency in which the past performance is displayed differs from the currency of the country in which you reside, then you should be aware that due to exchange rate fluctuations the performance shown may increase or decrease if converted into your local currency. For investment professional use only. Not for use by the general public.