- Wealth PMS (50L+)
This is a guest post by Faiz Memon, a happy wearer of many hats. Faiz is a student, an entrepreneur, an investor and an advisor for over two decades. Personal finance and investment management are his passion. Follow him on Twitter @_faizmemon_
“Therefore, just as sin entered the world through one man, and death through sin, and in this way death came to all people, because all sinned.” Romans 5:12
Sin. Can’t escape it, folks. From the minute we stumble into this world, it is filled with temptation and sin. A new voice has joined the righteous recently. Mr. Larry Fink, CEO of the largest asset manager in the world, Blackrock.(Larry Fink’s Letter to CEOs) Promoting ESG (Environmental, Social and Governance) based investing is an honorable endeavor. It also presents an interesting opportunity to invert his strategy. So what are some of the investments Mr. Fink & Blackrock will now avoid? A simple term comes to mind- Sin Stocks.
Sin stocks are public companies involved in the manufacture, sale and service of alcohol, tobacco, gambling, firearms, mining, oil and gas, etc… The list can go on, depending on our persuasions. Sin stocks are also an anomaly. Research covering 120 years of industry/company data from the US & UK found investing in sin stocks yields a handsome profit. Especially relative to other, more benign endeavors. (Equity Premia Around the World) A caveat here, this inference is drawn based on past returns and there is no guarantee of their future replication. A simple understanding of human nature tells us why this anomaly exists. Sin industries earn steady cash flow from our vices due to the nature of addictions. Addictions are not easily cast off.
It’s hard to imagine making money from sin in India. A strong governmental and cultural hand in all social activities supports that view. The lack of many listed and non-governmental names in the sin space is another constraint. Yet if one looks at comparative returns of sin vs. Nifty or Sensex over the past decade, there are some interesting observations.
A blend of equally weighted, largest capitalization stocks in the Tobacco, Alcohol and Oil/Mining industries boasts returns that handily beat the Nifty and Sensex.
Note: The value of this exercise is purely academic, for illustrative purposes and not investment advice. For the Sin blend, we’ve picked Godfrey Phillips and VST Industries from pure-play tobacco. United Spirits and United Brewery from the Alcohol. ONGC and Oil India from Oil. Finally Coal India and Vedanta from Mining.
On a compounded annual growth rate basis the outperformance is clear – Sin Blend 10%, Nifty 8%, and Sensex 8%. That’s an extra 2% per year compounded for a decade!
If one creates a base year of 2010 and plots the returns forward, the data looks even more compelling. Where the indices would have returned approximately 1.2 times our initial investment. The Sin stock blend would return 1.7 times our initial investment. A 40% difference in absolute performance, despite not including splits and dividends is astounding. One can also see from the data that such outperformance has recently slowed down. So this strategy certainly isn’t without risks, hindsight bias along with concentration risk and many more.
US investors have been better able to capitalize on excess returns from the sin anomaly. In a structured manner, through a diversified mutual fund. The Vice Fund (Ticker- VICEX) now renamed to a more palatable, Vitium Global was launched in 2002. The fund has been an outperformer vs the S&P 500 since its inception. Yet has in recent times lagged behind, just like its Indian brethren. Begging one to ask, is the tide turning on the ability to make money from sin? Is ESG investing slowly going to eat the world?
Yes and No.
Yes, because as more of us will use a passive indexed vehicle for our investments. Connecting our conscience to our investments will be a push of the button choice. The easier investing in virtue becomes, the harder it becomes to knowingly invest in vice.
The ESG landscape in India sports a few avenues for ethical investments. Their number will grow exponentially. Armed with a shiny new mousetrap. Many new funds and their distributors will soon be happy to go hunting with ESG.
The SBI Magnum Equity ESG Fund is the granddaddy of ESG mutual funds and sports a competitive return vs the Nifty and Sensex. (link to MF Analysis on Morningstar) A look at its top holdings reveals, among others, India’s largest construction and paint companies along with a host of automobile manufacturers. None of these should intuitively score highly on ESG ratings. More recent entrants Quantum and Axis round out a select menu of current ESG offerings. Performance and portfolios of the new funds are too short for a thorough analysis. That said, the issue at hand is the methodology and quality of ESG ratings. Exchanging one black box (active management) with another (ESG) isn’t something I’d advise.
One final point to note on active managers within mutual funds, ESG or otherwise. Because of the stupendous growth in passive investment vehicles, active managers are a dying breed. ESG investing is a natural turn for such companies. They portend to offer us a better world, through our investments. Active managers will expand their pie of offerings while positioning for the future. A future where index investments rule the world. And a wide swath of investors will use ESG as an easy third party filter for morality in their investments. Index and ESG will take the mantle from active long-only funds. Will the world be a better place for this change? Perhaps…
Sin stocks though won’t go so gently into the good and righteous night.
As money flows out from sin related industries, perversely their expected future returns go up. A profitable underlying business does not deteriorate at the pace of public opinion. The folks over at Marathon Asset Management have a nifty visual for this capital cycle. The capital cycle determines most of the future gains from an investment.
“Free markets do not just produce what we really want; they also produce what we want according to our monkey-on-the-shoulder tastes.” (Phishing for Phools by George A. Akerlof, Robert J. Shiller).
So in investing and markets, we earn excess returns from what buyers/users will pay for and not what they ‘’should’ want.
Many a sinful company, pays a dear dividend to their shareholders too. Juicy dividends cover some of the inherent risks in their business prospects. Consider though we live in a zero-bound interest rate world, starved for yield. It’s little surprise that high yielding sin stocks are a favorite of pension funds and retirees. A ready buyer of last resort.
To those hoping for the swift disruption of sin industries, contrast two instances of such an effort. Tesla disrupted beleaguered US car companies after taking on mountains of debt. But is now larger by market cap than GM & Ford combined! Juul Labs a vaping company was trying to disrupt the tobacco incumbents. It was bought out for a cool $13 Billion USD by none other than the Marlborough Man (Altria). A key difference between the two? The ability to independently invest heavily into infrastructure. Tesla took on debt to compete and Juul brought in a whale to make the investments. The ability to write a big fat cheque does count after all is said and done. Disruption is a certainty. Who is left standing after remains questionable.
In the energy space, a current group of oil majors has made less than a 3% allocation of their $250 Billion USD budget to alternatives. This is certain to change. Given the opportunity to earn superior returns these companies will take the intended route. The biggest balance sheets will be best able to carry large initial investments required for new alternatives. (Will the oil industry help address climate change?)
While I’m certainly not arguing that sinful industries won’t see disruption. Or threats of continued litigation. Or environmental costs/backlash. There will be challenges and some in the investment community will continue to shun sin stocks. But history shows us that sin industries will thrive in a highly competitive and restrictive regulatory environment. High barriers to entry and onerous regulations bless sin stocks with a wide moat.
So what is an individual to do? Scarred by the idea of leaving a burning dying world to the next generation. We also wonder if we have enough money to retire. Or for our immediate family needs. Activism and driving social change are a part of our shared narrative. An individual drives change most effectively on a local/micro level. And where we can effect change we must. Earning excess returns from the tobacco industry and concurrently supporting the local chapter of the World Wildlife Fund, is not at odds with our desired impact. It can be done without paying the additional fees for an active manager and one can still impact change in a local or even global community.
Be it vice or virtue, the decision to take the road less traveled is one that we must make on our own. On our own terms and we definitely shouldn’t follow the herd…
“The really dangerous people believe they are doing whatever they are doing solely and only because it is without question the right thing to do. And that is what makes them dangerous.” – Neil Gaiman – American Gods
Which strategy ESG vs Sin do you ascribe to?
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