Socially Responsible Investing Vs. Sin Stocks

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.

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. (For more on this investment strategy, read our related article A Prelude To Sinful Investing.)

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.

The Pax Balanced fund, launched on August 10, 1971, is the oldest operating SRI fund in the business. The Barrier Fund, known as the Vice Fund, launched on August 30, 2002, is the industry's oldest sin fund. A look at the two funds' annualized returns (as of May 2017) tells an interesting story. For ten years running, the sinners have done better.

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.

While there is no unilateral victory for either camp, things are not always as they seem. Where SRI once avoided gambling and alcohol, the Pax fund and a few others have relaxed that mandate, arguing that there are greater social ills and corporate governance issues to be concerned about and that gambling and alcohol are no longer viewed in the same light as they once were.

Interestingly, the funds tend to invest heavily in technology, healthcare and financial services. With scandal-plagued companies making headlines for all the wrong reasons, and gambling and alcohol stocks now in their portfolios, the value of SRI screens seems to have at least a small question mark beside it in the minds of neutral investors who favor neither the sinners nor the saints. Screens aside, 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). (To learn more, read Socially Responsible Mutual Funds.)

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. (Read Socially (Ir)responsible Mutual Funds to learn about your options.)

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.