By Jason Zweig | 2:09 pm ET Feb. 13, 2015
Image Credit: Christophe Vorlet
You might expect a mutual fund that has beaten the S&P 500 by an average of nearly two percentage points annually since 2002 to rake in billions of dollars from eager investors.
How come the USA Mutuals Barrier Fund has only $292 million?
The portfolio is allocated equally across four industries that many investors hate: tobacco, alcohol, gambling and defense. Over the past 10 years, the fund is up an annual average of 8.3%, after expenses, compared with 7.9% for the S&P 500—and just 7.2% for the Vanguard FTSE Social Index Fund, a feel-good portfolio of “socially responsible” stocks.
New research indicates that a distaste for “butts, booze, bets and bombs” may depress prices for such stocks in the short run, enabling “sin-vestors” to outperform in the long run. It also suggests that if you seek to beat the market, you should favor whatever is most profoundly unpopular.
A study released this past week by finance researchers Elroy Dimson, Paul Marsh and Mike Staunton of London Business School shows that over the past 115 years, U.S. tobacco stocks returned an average of 14.6% annually, compared with 9.6% for U.S. stocks.
Since such a differential grows powerfully over long periods, $1 invested in tobacco stocks in 1900 would have grown to $6.3 million by the end of 2014; the same $1 in the broader stock market would have grown to $38,255. Similar results have been found world-wide.
“It appears that when the people who abhor such stocks have shunned them, they have depressed the share prices but haven’t managed to destroy the industries,” Prof. Marsh says. “So investors who don’t have the same scruples have been able to pick up [these stocks] at a cheaper price.”
That doesn’t surprise Gerald Sullivan, portfolio manager of the USA Mutuals Barrier Fund. “Maybe socially responsible investors feel good about what they own,” he says, “and so the value they get doesn’t have to come from beating the market.”
Sin stocks’ “negative aura” makes attracting investors “a constant battle,” he says. Last year, the fund changed its name from the Vice Fund.
Twenty years ago, Burton Morgan had the same problem. The Ohio entrepreneur had run a private portfolio called Morgan SinShares. When he took it public, he rechristened it FunShares.
The firm that marketed FunShares changed Mr. Morgan’s words “liquor, smoking and gambling stocks” to “consumer nondurables that tend to be cyclical,” says Robert Pincus, a former director of the fund. Even so, the fund never got much above $10 million and shut down after Mr. Morgan died in 2003.
In November 2007, the FocusShares ISE SINdex Fund launched. The assets of the exchange-traded fund, which held tobacco, alcohol and gambling stocks (ticker symbol: PUF), peaked at around $10 million in mid-2008. The ETF was an early casualty of the financial crisis and shut down at the end of October 2008, says Erik Liik, former president of FocusShares.
The International Securities Exchange, an options market, maintains the SINdex, although no fund currently tracks it.
ISE calculates values for the SINdex back to Dec. 31, 1998. (The index didn’t exist then, and you couldn’t have invested in it.) The S&P 500 has returned an average of 5.2% annually since the end of 1998, counting dividends, according to S&P Dow Jones Indices. Over the same period, the SINdex has gained an average of 16.1% annually.
If you had been able to invest $10,000 in each index at the end of 1998, you now would have $110,872 in the SINdex and $22,729 in the S&P 500. Even since 2007, it has beaten the S&P 500 by an average of 1.1 percentage points annually.
Sin stocks aren’t recession-proof, and there aren’t enough of them to smooth out what can be a bumpy ride. The SINdex holds only 29 companies; the Barrier Fund, 46. When one sinful sector does poorly, it drags down the whole portfolio. The Barrier Fund lost 41.6% in 2008 and gained only 0.8% last year, as gambling stocks crapped out. And the fund has a 1.47% annual fee, or $147 per $10,000 investment, so it is far more costly than an index fund that holds the broad market.
Still, there is an investing lesson in these results of sin-vesting. For excess return to persist, the typical investor has to hate something about the companies that produce it; otherwise, they would never be cheap enough to offer lasting value.
The past few years, fund companies have been flogging so-called alternative or “smart beta” strategies: stocks with high dividends, low fluctuations in price, high profitability, low market valuation and so on.
All have been shown to beat the market over long periods in the past. But will they in the future?
“You have to worry that some of these results are just due to chance and won’t persist, or that once they’re publicized their popularity will lead them to self-destruct,” Prof. Marsh says.
But the behavioral distaste attached to sin stocks is so visceral, he says, that it seems likely to persist.
Therefore, before you climb onto the bandwagon for an alternative strategy, ask why something that is becoming so popular should offer a durable performance advantage.
Until investing in it feels like a sin, maybe you should wait.
Source: The Wall Street Journal