The Dark Enemy of Responsible Mutual Funds: Does the Vice Fund Offer More Financial Virtue?

Abstract

Several recent studies led by Hong & Kacperzcyk (2009, Journal of Financial Economics) document that companies in industries perceived as sinful - so called sin stocks (i.e. alcohol, tobacco, gambling) - deliver a significant and positive abnormal stock market performance. This potentially attractive characteristics make these sin stocks a relevant investment opportunity for pension funds. In fact, following a rather conservative interpretation of pension funds' fiduciary duty, one might argue that pension funds have to investment overproportionally in sin stocks due to their seemingly superior returns to act in the best financial interest of their beneficiaries. This best financial interest, however, is unlikely the best interest of the beneficiary from a wider wellbeing perspective as, for instance, investments in tobacco companies are unlikely supportive of public health and hence beneficiaries' life expectancy. Before one dives into this legal paradoxon it is worth considering the practicalities of investing in these so called sin stocks, as the academic studies documenting their preferential characteristics used nearly exclusively hypothetical portfolios and not actual investment funds. In fact, only one sin stock based investment fund exists to the best our of knowledge, the Vice Fund. In this chapter, we pursue the first in depth analysis of the financial attractiveness of the Vice Fund, which penalizes instead of rewards responsible corporations. Despite the financial potential of the Vice Fund’s underlying sin stocks has recently been indicated, we find the Vice Fund’s abnormal return to be statistically indistinguishable from zero. Interestingly, the Vice Fund managers possess significantly value destructing directional trading and crisis management skills. Consequently, we cannot see any practical reason why pension funds would have to invest overproportionally in sin stocks, as their actually realised investment performance is no better than ordinary. Our finding is not necessarily inconsistent with Hong and Kacperczyk (2009), as they regressed equal weighted sin stocks against a value weighted market benchmark and economy wide investment style controls, which means that their significant positive alphas could have resulted from a clever portfolio weighting instead of any sin characteristics (i.e. the overproportionally weighted small sin stocks could have outperformed the underproportionally weighted large sin stocks).