Moral judgment on "sin stocks" means higher returns for vice-friendly investors: UBC study
VANCOUVER, BC – Society’s disapproval of alcohol, tobacco and gambling means that some investors – mostly public institutions – lose out while others investors gain on these undervalued “sin stocks,” according to a study conducted by the Sauder School of Business at the University of British Columbia.
Sauder Prof. Marcin Kacperczyk and co-author Harrison Hong of Princeton University analyzed stock markets and the impact they feel from society’s framework of morals, traditions and laws.
“While sinful stocks aren't necessarily good for the soul, they do deliver higher returns,” says Kacperczyk, adding that the penchant for vice can translate into bigger returns for institutional or individual investors.
“Our analysis associates social norms with significant price effects. Sin stocks are under-priced and outperform comparable stocks,” says Kacperczyk.
Their study, The Price of Sin: The Effects of Social Norms on Markets, shows that some investors – particularly institutions subject to public scrutiny – pay a financial price for not holding stocks that are linked to human vice.
Institutions such as pension funds, universities, religious organizations, and banks are less willing than other types of investors to hold sin stocks due to the public nature of their investments, their diverse customer bases, and their exposure to public scrutiny. In their absence, some mutual funds, hedge funds, and individual investors may take advantage of that suppressed demand and the better performance that results from the sin stock effect.
The case of tobacco best illustrates the researchers’ hypothesis. A half-century ago, cigarettes were as acceptable to the mainstream as soft drinks or breakfast cereal. Today, they are held responsible by the medical community as the leading cause of preventable death in North America, and an affront to public health globally.
Kacperczyk and Hong found that stock market valuations for tobacco companies have corresponded with the industry's fall from mainstream favor in recent decades. During the 1950s, tobacco stocks were valued in line with other sectors, but today they are undervalued relative to other industries. As fewer institutional investors want to be associated with the nicotine trade, the pool of investors who decides to hold them needs to share proportionately more risk and reward.
The case of gambling may enjoy a possible flipside of the researchers’ hypothesis. The gaming industry has enjoyed greater mainstream acceptance in recent years, and as a result, the researchers expect less undervaluation of stocks in that sector in the years to come.
As for defense stocks, which were not included in the study, Kacperczyk points to the industry as fertile grounds for future research in the area of social norms and stock markets.
“It’s interesting to note that defense isn’t necessarily a sin in the United States,” he says. “So the next step would be to see how defense stocks listed in the United States differ from those in Europe, where the industry is more likely to be frowned upon by the general public.”
The paper in its entirety is available at Sauder School of Business website, at: http://www.sauder.ubc.ca/.
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