Sin Stocks Research Articles

Deviations From Norms and Informed Trading

This paper proposes and tests the conjecture that sophisticated individuals deviate from established personal and social norms only when the perceived benefits are sufficiently large. We apply this broad idea to the context of institutional investing and predict that norm-constrained investors deviate from norms when they have compelling information. Consequently, they should earn higher abnormal returns from those investments. We test this prediction using norms against gambling and holding stocks. Consistent with our conjecture, we find that when gambling-averse institutions invest in lottery-type stocks, they earn higher abnormal returns on their lottery stock holdings, outperforming the holdings of gambling-tolerant institutions. Similarly, institutions that are averse to holding sin stocks earn higher abnormal returns on those they choose to hold. Overall, these results indicate that deviations from established social norms can be used to identify informed investing.

Do Deviations from Investor Tastes Signal Informed Trading?

This paper provides a novel method for identifying informed institutional trading by conditioning on investors’ tastes. Given an information signal about a stock, an investor’s tastes for certain characteristics of that stock can influence his decision to trade. Thus, trades which deviate from an investor’s tastes are more likely to reflect information. I test this hypothesis with respect to institutional investors’ taste for positive (expected) skewness. Measuring skewness preferences by their past portfolio allocations, I find that the most skewness-averse institutions earn abnormal returns of 152-207 basis points per quarter on their holdings of stocks with high expected idiosyncratic skewness (EISKEW). Their holdings of high EISKEW stocks outperform those of the most skewness-loving institutions by 126-128 basis points per quarter, and this outperformance is stronger for fresh holdings and among the holdings of more aggressive institution types. I confirm the main result using an alternative proxy for skewness preferences based on local religious beliefs. An analysis of institutions’ sin stock holdings provides complementary evidence using another dimension of investor tastes, supporting the hypothesis that trades which deviate from an investor’s tastes are more likely to reflect information.

Faith‐based and sin portfolios

PurposeThe purpose of this paper is to investigate relative portfolio performance between sin stock returns and faith‐based returns.Design/methodology/approachSimilar to Hong and Kacperczyk, Jensen's alpha was utilized to conduct tests along with three asset‐pricing models and rolling regression technique to reveal that faith‐based and sin betas move in opposite directions during most of the sample period.FindingsNorm‐neglect was found, in that Jensen's alpha is positive and significant for the sin portfolio. Further, evidence in favor of norm‐conforming investor behavior was found, where Jensen's alpha is negative and significant for the faith‐based portfolio. These findings provide evidence that the sin portfolio outperforms the faith‐based portfolio relative to the market. A rolling regression technique reveals that faith‐based and sin betas tend to move in opposite directions during most of the sample period. The evidence suggests that faith‐based beta has an average estimated beta of one, mimicking the market. The sin portfolio, however, has an average estimated beta of one‐half. Finally, the reward‐to‐risk measure, Sharpe ratio, is statistically higher for the sin portfolio relative to the faith‐based portfolio.Originality/valueThis paper contributes to the literature in the following distinct ways. First, three asset‐pricing models are estimated to examine Jensen's alpha for sin and faith‐based portfolios. Second, a rolling regression procedure is used to examine the dynamic behavior relative to the market of the sin and faith‐based portfolios. Third, use is made of the Jobson and Korkie test, which allows for statistical comparisons of Sharpe ratios. Lastly, daily instead of monthly data and a different sample period are used to examine the research questions posed in this study.

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

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).

Sin Stock Returns Over the Business Cycle

This paper mitigates previous evidence of out-performance of sin stocks – stocks of companies involved in producing tobacco, alcohol and gaming – on the U.S. market. It has been shown empirically that sin stocks earn an abnormal risk-adjusted return compared to industries with similar characteristics. Based on a conditional analysis accounting for different business conditions, I invalidate this hypothesis by first testing a conditional model using different macroeconomic variables and second by looking at earnings growth over expansion and recession periods. Thus, even though sin stocks are unique because of the addictive nature of sin consumption, they are only as recession-proof as some other industry-comparable stocks. However, I find evidence that sin stocks still outperform the overall market during bad times, meaning that socially responsible investors pay a financial cost when avoiding these stocks because of social and ethical criteria.

The price of sin: The effects of social norms on markets

We provide evidence for the effects of social norms on markets by studying “sin” stocks—publicly traded companies involved in producing alcohol, tobacco, and gaming. We hypothesize that there is a societal norm against funding operations that promote vice and that some investors, particularly institutions subject to norms, pay a financial cost in abstaining from these stocks. Consistent with this hypothesis, we find that sin stocks are less held by norm-constrained institutions such as pension plans as compared to mutual or hedge funds that are natural arbitrageurs, and they receive less coverage from analysts than do stocks of otherwise comparable characteristics. Sin stocks also have higher expected returns than otherwise comparable stocks, consistent with them being neglected by norm-constrained investors and facing greater litigation risk heightened by social norms. Evidence from corporate financing decisions and the performance of sin stocks outside the US also suggest that norms affect stock prices and returns.

The Determinants of Sin Stock Returns: Evidence on the European Market

This article deals with the time-series variation in average sin stock returns – returns on publicly-traded companies involved in producing tobacco, alcohol, and gaming. Next to nothing has been written about this class of stocks, especially on the European stock market. The hypothesis I explore in this paper is that sin stock returns depend on legal and cultural characteristics such as religious preferences, the level of excise taxation, and the degree of litigation risk. Using data on 18 European countries over the period 1975-2006, my results show evidence that Protestants are more “sin averse” than Catholics, and require a significant premium on sin stocks. Moreover, sin stocks have higher risk-adjusted returns when they are located in a country with high excise taxation; and sin stocks outperform other stocks when the litigation risk is higher, even after controlling for well-known risk factors such as market capitalization and book-to-market ratio. These findings suggest that sin stock returns depend on both legal and religious environments of each country.

Sin Stock Returns

In this article, the authors examine the issue of how social values affect economic values. Based on a small subset of the stock universe that has been generally associated with sin-seeking activities, such as alcohol consumption, adult services, gaming, tobacco, weapons, and biotech alterations, the authors find that a sin portfolio produced an annual return of 19% over the study period, unambiguously outperforming common benchmarks in terms of both magnitude and frequency. Several likely reasons for the positive excess returns in sin stocks are identified. The authors argue that trustees or fiduciaries who develop institutional investment policy statements should fully understand the economic consequences of screening out stocks of companies that produce a product inconsistent with their value systems. In addition, institutional investors should question if the cost to uphold common social standards is worthwhile.

A Wolf in Sheep's Clothing: The Use of Ethics-Related Terms in 10-K Reports

We examine the occurrence of ethics-related terms in 10-K annual reports over 1994-2006 and offer empirical observations on the conceptual framework of Erhard, Jensen, and Zaffron (2007). We use a pre-Sarbanes-Oxley sample subset to compare the occurrence of ethics-related terms in our 10-K data with samples from other studies that consider virtue-related phenomena. We find that firms using ethics-related terms are more likely to be sin stocks, are more likely to be the object of class action lawsuits, and are more likely to score poorly on measures of corporate governance. The consistency of our results across these alternative measures of behavior suggests that managers who portray their firm as ethical in 10-K reports are more likely to be systematically misleading the public. These results are consistent with the integrity-performance paradox.

Are Sin Stocks Paying the Price for their Accounting Sins?

A recent study by Hong and Kazperczyk (2005) finds that sin stocks - publicly-traded stocks in the gaming, tobacco, and alcohol industries are neglected by the stock market despite generating abnormal stock returns. We examine a rational explanation for their findings. Are the excess returns and investor neglect of sin stocks attributable to higher levels of information risk arising from poor financial reporting quality? Contrary to expectations, we find that sin firms exhibit better financial reporting quality along three dimensions: earnings and accrual persistence, predictability of earnings for future cash flows, and timely loss recognition. Our results are more consistent with a supply-side argument, whereby sin firms have high financial reporting quality to attract a wider investment and analyst base. Despite superior returns and financial reporting quality, investors are willing to bear a financial cost in order to comply with societal norms and reflect non financial tastes in their portfolio by neglecting sin stocks.

The Price of Sin: The Effects of Social Norms on Markets

We provide evidence for the effects of social norms on markets by studying stocks - publicly-traded companies involved in producing alcohol, tobacco, and gaming. We hypothesize that there is a societal norm to not fund operations that promote vice and that some investors, particularly institutions subject to norms, pay a financial cost in abstaining from these stocks. Consistent with this hypothesis, sin stocks are less held by certain institutions, such as pension plans (but not by mutual funds who are natural arbitrageurs), and less followed by analysts than other stocks. Consistent with them facing greater litigation risk and/or being neglected because of social norms, they outperform the market even after accounting for well-known return predictors. Corporate financing decisions and time-variation in norms for tobacco also indicate that norms affect stock prices. Finally, we gauge the relative importance of litigation risk versus neglect for returns. Sin stock returns are not systematically related to various proxies for litigation risk, but are weakly correlated to the demand for socially responsible investing, consistent with them being neglected.