Why this ETF of ‘sin’ stocks is likely to reward investors with saintly results

It’s a good bet that a forthcoming exchange-traded fund that invests in “B.A.D.” stocks will outperform the U.S. market.

The new ETF, which has yet to be launched and doesn’t have a ticker, will be benchmarked to an index of betting, alcohol and drugs companies. The formal registration papers for the “B.A.D. ETF” were filed with the SEC in late September.

One of several reasons I have for betting that the fund will outperform the S&P 500 is the historical outperformance of so-called sin stocks. Consider the results of a study conducted by Elroy Dimson, a finance professor at Cambridge University, Paul Marsh, a finance professor at the London Business School, and Mike Staunton, director of that institution’s London Share Price Database. The chart below shows what they found for alcohol and tobacco stocks’ performance over the past 120 years.

In the U.S. market, tobacco stocks on average outperformed the overall market by 4.6 annualized percentage points. In the U.K. market, alcohol stocks beat the overall market by 2.2 annualized percentage points. The researchers didn’t have full 120-year data for alcohol stocks in the U.S. or tobacco stocks in the U.K., but the partial-period returns for those two sectors in those countries show market outperformance of similar magnitudes.

Even more dramatic market-beating returns were reported by another study that focused on the 37-year period from 1970 to 2007 across 21 different countries. To average returns across these different countries, the researchers calculated how much each stock outperformed the stock market index of its home country (its alpha). The table below reports the average of these alphas.

Sector Average annualized alpha relative to home country stock market
Adult Services 9.96 annualized percentage points
Alcohol 5.57
Gaming 26.35
Tobacco 14.71
Why sin stocks outperform

There are theoretical reasons to expect sin stocks to beat the market. The standard Finance 101 explanation is that a sin company’s cost of capital will go up if a significant group of investors actively shun it. As Dimson, Marsh, and Staunton put it: “A heightened cost of capital represents an elevated expected return. Choosing to exit ‘sinful’ stocks can cause them to offer higher returns to those less troubled by ethical considerations.”

Cliff Asness, founder of AQR Capital Management, put it more bluntly: “Frankly, it sucks that the virtuous have to accept a lower expected return to do good, and perhaps sucks even more that they have to accept the sinful getting a higher one. Well, embrace the suck as without it there is no effect on the world, no good deed done at all. Perhaps this necessary sacrifice is why it’s called ‘virtue’.”

There may also be a risk-based explanation for sin company stocks’ outperformance. That’s because these companies probably face greater risks than non-sinful companies because of possible regulatory actions or litigation. To the extent that is the case, their stocks’ alphas could represent the compensation investors demand to incur that greater risk.

More research is no doubt needed. In the meantime, note carefully that the alphas documented by past studies are averages across many years and decades. By no means is it the case that sin stocks have beaten the market in each and every year.

Nevertheless, if the future is like the past, such stocks will outperform the broad market over the long term.

Trending Ideas

Featured Stocks On The Move

Daily Rundown

Top 3 Stocks in Leading Sectors
  • 3 Oil Field Machinery Stocks To Buy Now

    Matrix Service Company (MTRX) Matrix Service Company provides engineering, fabrication, construction, and maintenance services to energy and industrial markets. The company operates through segments such as Storage and Terminal Solutions,... Read More

  • 3 Restaurant Stocks To Buy Now

    Brinker International, Inc. (EAT) Brinker International, Inc. is a leading casual dining restaurant company, operating well-known brands such as Chili’s Grill & Bar and Maggiano’s Little Italy. The company focuses... Read More

  • 3 Coal Stocks To Buy Now

    Natural Resource Partners L.P. (NRP) Natural Resource Partners L.P. is a master limited partnership that owns, manages, and leases a diversified portfolio of mineral properties in the United States. The... Read More

  • 3 Real Estate Developer Stocks To Buy Now

    IRSA Inversiones y Representaciones Sociedad Anónima (IRS) IRSA Inversiones y Representaciones Sociedad Anónima is a leading real estate company in Argentina, engaged in the acquisition, development, and management of diversified... Read More

  • 3 Gas Distribution Stocks To Buy Now

    New Jersey Resources Corporation (NJR) New Jersey Resources Corporation is an energy services holding company that provides regulated natural gas distribution services through its subsidiary, New Jersey Natural Gas. The... Read More

  • 3 Food Product Stocks To Buy Now

    The Chefs’ Warehouse, Inc. (CHEF) The Chefs’ Warehouse, Inc. is a premier distributor of specialty food products, serving high-end restaurants, hotels, and gourmet food stores across the United States and... Read More

  • 3 HVAC Stocks To Buy Now

    Featured Content Lennox International Inc. (LII) Lennox International Inc. is a global leader in energy-efficient climate control solutions, specializing in heating, ventilation, air conditioning, and refrigeration (HVACR) products. The company... Read More

  • 3 Hotel Stocks To Buy Now

    Featured Content Hyatt Hotels Corporation (H) Hyatt Hotels Corporation operates a global portfolio of luxury, full-service, and lifestyle hotels, as well as vacation properties. Known for its premium hospitality offerings,... Read More

  • 3 Tobacco Stocks To Buy Now

    Featured Content Turning Point Brands, Inc. (TPB) Turning Point Brands, Inc. is a consumer products company that manufactures and markets tobacco products and alternative smoking accessories. The company’s portfolio includes... Read More

  • 3 Life Insurance Stocks To Buy Now

    Featured Content F&G Annuities & Life, Inc. (FG) F&G Annuities & Life, Inc. specializes in annuities and life insurance products designed to meet the long-term financial planning needs of clients.... Read More

  • 3 Soft Beverage Stocks To Buy Now

    Featured Content Westrock Coffee Company (WEST) Westrock Coffee Company is a leading integrated coffee, tea, and extract service provider, offering comprehensive solutions from sourcing and roasting to packaging and distribution.... Read More

  • 3 Medical Info System Stocks To Buy Now

    Featured Content Clover Health Investments, Corp. (CLOV) Clover Health Investments, Corp. is a healthcare technology company focused on improving health outcomes for America’s seniors. The company offers Medicare Advantage plans... Read More