While environmental, social, and governance (ESG) investing continues to gain in popularity, economic theory suggests the share prices of “sin” businesses (typically those involved in the gambling, tobacco, alcohol, guns, and defense industries) will become depressed if a large enough proportion of investors choose to avoid them—the “shunned-stock hypothesis.” Such stocks would have a higher cost of capital because they would trade at a lower price-to-earnings (P/E) ratio—providing investors with higher expected returns. Some investors may view those higher expected returns as compensation for the emotional cost of exposure to offensive companies. On the other hand, socially conscious investors may be willing to accept less-than-optimal returns while gaining peace of mind knowing they are not promoting activities they believe are detrimental to society and/or one’s health. 1 The evidence from research papers such as 2009’s “The Price of Sin: The Effects of Social Norms on Markets,” the 2017 papers “Fewer Reasons to Sin: A Five-Factor Investigation of Vice Stocks” and “Sin Stocks Revisited: Resolving the Sin Stock Anomaly,” and the 2020 study “The Underpricing of Sin Stocks” has found:
- Sin stocks have provided abnormal risk-adjusted returns due to neglect by institutional and retail investors, who lean toward the side of ESG.
- The abnormal return to sin stocks occurred because they are more profitable and less wasteful with investment than the average corporation.
- Sin stocks tend to be low-beta stocks and have highly statistically significant loadings on the betting-against-beta (BAB) factor.
- Sin firm IPOs are more underpriced (22.3%) than non-sin firm IPOs.
- Sin stocks have had higher returns and Sharpe ratios than the market portfolio, and sin industry funds’ returns have been less correlated with each other than they have been with the market portfolio.
- The betas of the sin portfolios were less than one, indicating they have less systematic risk than the market portfolio (they are more defensive).
- Bad news events have a lesser impact on sin stock return volatility than do good news events.