Does vice pay? It depends on where you look.

Indeed, there's plenty of evidence which shows that vice or sin stocks outperform the market (more on this later) although a recent study published in The Journal of Law and Financial Management, a publication of The University of Sydney, questions these results.

The study was conducted by Greg Richey, a lecturer of finance at California State University, San Bernardino who, in his own words, was looking to determine, "how the individual vice industries have performed against the market portfolio".

Abstract:

"This article examines the return characteristics of a portfolio of US 'vice stocks', firms that manufacture and sell socially irresponsible products such as alcohol, tobacco, gaming services and national defense. First of all, I construct a portfolio using the daily returns of 41 vice stocks over the period October 2007 to October 2013 and find the Jensen’s alpha (CAPM), Fama-French Three Factor and Carhart Four-Factor results for the entire portfolio, the entire portfolio during bear and bull markets, and each vice industry individually. Full-period results show a positive, yet insignificant alpha for the entire portfolio and each vice industry. Bear market results show a positive and significant alpha for the entire portfolio as well as for all industry portfolios except the tobacco industry. Bull market results for the portfolio are less conclusive with a significant alpha only in the three and four-factor models."

Source: Richey, Greg M., Can Naughty Be Nice for Investors: A Multi-Factor Examination of Vice Stocks (August 3, 2014). Journal of Law and Financial Management, Vol. 13, No. 1, June 2014, pp. 18-29. Available at SSRN:http://ssrn.com/abstract=2475646

These results conflict with the findings of many other studies, all of which have concluded that vice stocks do outperform by a significant margin over the long-term. It should be noted that Greg Richey's study only covers six years of performance. Other studies look at returns over several decades of returns.

Sin stocks: Outperformance

One of the most comprehensive studies on the topic was conducted by Elroy Dimson, Paul Marsh and Mike Staunton of the London Business School. Their work of financial archaeology was published in Credit Suisse Group AG Global Investment Returns Yearbook 2015.

Using data compiled over the last 115 years, Elroy Dimson, Paul Marsh and Mike Staunton showed that tobacco stocks in particular beat the wider equity market by 4.5% per annum in the US and 2.6% per annum in the UK (a slightly shorter study period was used 1920-2014).

Another study, entitled Sin Stock Returns, Fabozzi, Ma and Oliphant examined a larger number of sin stocks, drawn from multiple markets from 1970-2007. In this study, the authors used a carefully selected set of criteria to define sinful activity. Only 267 stocks were deemed sufficiently liquid to be investable.

The chart below, as put together by Credit Suisse, shows the results of the study. Each stock has a unique start- and end-date in the sample and the authors computed the excess return for each stock relative to the return on the capitalization-weighted index for the market over the interval for which it trades. Overall, the average excess return over the wider market varied by industry. Alcohol stocks produced the lowest mean return of 5.3%, followed by 9.6% for biotech, 10% adult services, 14.7% tobacco, 24.6% weapons and 26.4% for gaming.

Sin stocks outperform

A market anomaly

The outperformance of tobacco and other ‘sin stocks’ is something I’ve written about before, and seems to be somewhat of a market anomaly. A study published within the 2009 Journal of Financial Economics, written by H. Hong and M. Kacperczyk and entitled, The Price of Sin: The Effects of Social Norms on Markets, provides evidence that the stocks of publicly traded companies involved in producing alcohol, tobacco, and gaming have long acted differently to the rest of the market.

Over the entire 81 years of the Hong - Kacperczyk study, US sin stocks provided an annualized excess return, relative to non-sin stocks of 3% to 4% per year. During 1985-2006, international sin stocks outperformed by around 2.5% per year.

And finally, a less scientific but still relevant study from asset manager SigFig, tracks over $350B in assets through partnerships with Fidelity, Schwab, and Ameritrade. SigFig’s data shows that 1 in 8 stock investors (12.5%) on its platform owns a vice stock. As the chart below shows, investors with positions in alcohol and tobacco companies outperformed the average investor over the twelve-month period. Although vice investors still underperformed the S&P 500 (SPY) over the period.

Sin stock returns