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.
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.”
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.
“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.
The contents of this document have not been reviewed by the Securities and Futures Commission ("SFC") in Hong Kong. If you are in any doubt about any of the contents of this document, you should obtain independent professional advice. This document has been distributed by Robeco Hong Kong Limited (‘Robeco’). Robeco is regulated by the SFC in Hong Kong.
This document has been prepared on a confidential basis solely for the recipient and is for information purposes only. Any reproduction or distribution of this documentation, in whole or in part, or the disclosure of its contents, without the prior written consent of Robeco, is prohibited. By accepting this documentation, the recipient agrees to the foregoing
This document is intended to provide the reader with information on Robeco’s specific capabilities, but does not constitute a recommendation to buy or sell certain securities or investment products. Investment decisions should only be based on the relevant prospectus and on thorough financial, fiscal and legal advice. Please refer to the relevant offering documents for details including the risk factors before making any investment decisions.
The contents of this document are based upon sources of information believed to be reliable. This document is not intended for distribution to or use by any person or entity in any jurisdiction or country where such distribution or use would be contrary to local law or regulation.
Investment Involves risks. Historical returns are provided for illustrative purposes only and do not necessarily reflect Robeco’s expectations for the future. The value of your investments may fluctuate. Past performance is no indication of current or future performance.
Please read this information carefully.
This website is prepared and issued by Robeco Hong Kong Limited ("Robeco"), which is a corporation licensed by the Securities and Futures Commission in Hong Kong to engage in Type 1 (dealing in securities); Type 4 (advising in securities) and Type 9 (asset management) regulated activities. The Company does not hold client assets and is subject to the licensing condition that it shall seek the SFC’s prior approval before extending services at retail level. This website has not been reviewed by the Securities and Futures Commission or any regulatory authority in Hong Kong.
2. Important risk disclosures
2. Important risk disclosures Robeco Capital Growth Funds (“the Funds”) are distinguished by their respective specific investment policies or any other specific features. Please read carefully for the risks of the Funds:
3. Local legal and sales restrictions
The information contained in the Website is being provided for information purposes.
Neither information nor any opinion expressed on the Website constitutes a solicitation, an offer or a recommendation to buy, sell or dispose of any investment, to engage in any other transaction or to provide any investment advice or service. The information contained in the Website does not constitute investment advice or a recommendation and was prepared without regard to the specific objectives, financial situation or needs of any particular person who may receive it. An investment in a Robeco product should only be made after reading the related legal documents such as management regulations, prospectuses, most recent annual and semi-annual reports, which can be all be obtained free of charge at www.robeco.com/hk/en and at the Robeco Hong Kong office.
4. Use of the Website
The information is based on certain assumptions, information and conditions applicable at a certain time and may be subject to change at any time without notice. Robeco aims to provide accurate, complete and up-to-date information, obtained from sources of information believed to be reliable. Persons accessing the Website are responsible for their choice and use of the information.
5. Investment performance
No assurance can be given that the investment objective of any investment products will be achieved. No representation or promise as to the performance of any investment products or the return on an investment is made. The value of your investments may fluctuate. The value of the assets of Robeco investment products may also fluctuate as a result of the investment policy and/or the developments on the financial markets. Results obtained in the past are no guarantee for the future. Past performance, projection, or forecast included in this Website should not be taken as an indication or guarantee of future performance, and no representation or warranty, express or implied, is made regarding future performance. Fund performance figures are based on the month-end trading prices and are calculated on a total return basis with dividends reinvested. Return figures versus the benchmark show the investment management result before management and/or performance fees; the fund returns are with dividends reinvested and based on net asset values with prices and exchange rates of the valuation moment of the benchmark.
Investments involve risks. Past performance is not a guide to future performance. Potential investors should read the terms and conditions contained in the relevant offering documents and in particular the investment policies and the risk factors before any investment decision is made. Investors should ensure they fully understand the risks associated with the fund and should also consider their own investment objective and risk tolerance level. Investors are reminded that the value and income (if any) from shares of the fund may be volatile and could change substantially within a short period of time, and investors may not get back the amount they have invested in the fund. If in doubt, please seek independent financial and professional advice.
6. Third party websites
This website includes material from third parties or links to websites maintained by third parties some of which is supplied by companies that are not affiliated to Robeco. Following links to any other off-site pages or websites of third parties shall be at the own risk of the person following such link. Robeco has not reviewed any of the websites linked to or referred to by the Website and does not endorse or accept any responsibility for their content nor the products, services or other items offered through them. Robeco shall have no liability for any losses or damages arising from the use of or reliance on the information contained on websites of third parties, including, without limitation, any loss of profit or any other direct or indirect damage. Third party off-site pages or websites are provided for informational purposes only.
7. Limitation of liability
Robeco as well as (possible) other suppliers of information to the Website accept no responsibility for the contents of the Website or the information or recommendations contained herein, which moreover may be changed without notice.
Robeco assumes no responsibility for ensuring, and makes no warranty, that the functioning of the Website will be uninterrupted or error-free. Robeco assumes no responsibility for the consequences of e-mail messages regarding a Robeco (transaction) service, which either cannot be received or sent, are damaged, received or sent incorrectly, or not received or sent on time.
Neither will Robeco be liable for any loss or damage that may result from access to and use of the Website.
8. Intellectual property
All copyrights, patents, intellectual and other property, and licenses regarding the information on the Website are held and obtained by Robeco. These rights will not be passed to persons accessing this information.
10. Applicable law
The Website shall be governed by and construed in accordance with the laws of Hong Kong. All disputes arising out of or in connection with the Website shall be submitted to the exclusive jurisdiction of the courts of Hong Kong.