Is it better to be bad than to be good? It is a question that has plagued humanity since the beginning of time, and the world of investing has not been immune to the controversy. In one corner are the fans of socially responsible investing (SRI), and in the other corner are the fans of sin stocks.
Key Takeaways
- Over the past decade, socially responsible investing (SRI), has become an important investment trend, with people choosing only those stocks that support their communities, the environment, and good corporate governance.
- SRI stocks can be contrasted with “sin stocks”, those companies that engage in activities that can be harmful, such as tobacco, alcohol, and firearms as well as large polluters.
- While SRI may fit your moral convictions, economists warn that investing solely in SRI stocks leaves important gaps in a diversified portfolio that can limit returns and concentrate risk.
SRI vs. Sin Stocks
SRI fans prefer an investment strategy that views successful investment returns and responsible corporate behavior as going hand in hand. They believe that by combining certain social criteria with rigorous investment standards, they can identify securities that will earn competitive returns and help build a better world.
Proponents of sin stocks have traditionally favored companies in the gambling, alcohol, tobacco, and firearms industries. Any companies that make a profit have a place in their portfolios, regardless of whether the firm builds nuclear power plants, sells components for land mines, or has questionable labor practices. This camp points out that somebody is going to profit from these industries and argues that there’s no reason to sit on the sidelines and miss out on the opportunity.
Buy Into Sin, or Put Your Money Behind Your Convictions?
SRI fans argue that it’s possible to do some good while making money. Their argument rests on the idea that socially responsible companies are likely to be well managed because their underpinnings are based on solid values. Sin stock fans argue that SRI mandates pass up good opportunities in companies that have strong fundamentals, trading profits for a feel-good factor.
The sin stock crowd feels good when their investments deliver solid returns. They would rather put money in the bank by backing industries that meet consumer demand than starve for their convictions. Modern portfolio theory (MPT) seems to back their argument, as constructing the optimal portfolio should be more challenging if some stocks are removed from the universe of possible investments.
A Look at the Numbers
The Pax Sustainable Allocation Fund, formerly the Pax Balanced Fund, launched on August 10, 1971 and was renamed on December 18, 2019, is the oldest operating SRI fund in the business. The Vice Fund, launched on August 30, 2002, is considered one of the industry’s oldest sin funds. A look at the two funds’ annualized returns (as of early 2022) tells an interesting story. For ten years running, the socially responsible fund has done better.
**Pax Sustainable Fund, as of August 31, 2022; Vice Fund, as of June 30, 2022.
Comparing the funds to their respective indexes provides another perspective. Pax delivered index-like performance across the board, while Vice fell short of its benchmark in every metric.
Complications
Interestingly, SRI funds tend to invest heavily in technology, healthcare, and financial services. It is also important to consider the cyclical nature of the markets. When sectors, such as technology and healthcare, are topping the charts, sin stocks may be out of favor or at least underperforming the market leaders. Similarly, when stocks that SRI funds won’t buy are leading the pack, sin stocks will outperform.
It is also worth noting that the universe of SRI funds vastly outnumbers the universe of sin funds. There are dozens of SRI funds, including big names, such as Dow Jones and Calvert, and a number of exchange-traded funds (ETFs).
On the sin stock side, there are fewer than half a dozen offerings, even with ETFs included, although there are plenty of individual securities that fit the mold, so constructing a portfolio based on stocks that SRI funds won’t hold is easy to do.
Which Funds Are More Prevalent, SRI or Sin?
The world of SRI funds is much larger than that of sin funds. There are fewer than half a dozen sin offerings, including ETFs, but dozens of SRI funds, such as those of Dow Jones and Calvert, and many ETFs.
What Is Modern Portfolio Theory (MPT)?
MPT is a practical method for selecting investments to maximize their overall returns within an acceptable level of risk through diversification. Most investments are either high risk and high return or low risk and low return. Harry Markowitz, who pioneered the theory, argued that investors could achieve their best results by choosing an optimal mix of the two based on an assessment of their individual tolerance to risk.
Do SRI Funds Hold Some Sin Funds’ Former Favorites, Such as Gaming and Alcohol Stocks?
Yes, some do. Gaming and alcohol companies are viewed more favorably now than they once were, and some investors contend that there more pressing social ills and corporate governance issues that are worse for society than those two.
The Bottom Line
Where should you put your money? If your moral convictions won’t permit investments in sin stocks, your choice has already been made. Just be sure to learn about the screening criteria for the funds that you are considering or you could end up with companies that don’t represent your values in your portfolio. If you’re just looking to make a solid investment, moral convictions aside, a diversified portfolio including both saints and sinners may be the better choice.