Feature – Sin stocks


shift to a more carbon neutral system of energy production that does not impact the climate,” he says, adding: “BP and Shell do invest in renewables but you want them to do more.” Another complicating factor when it comes to assessing which stocks meet ethical benchmarks is that of the chains of owner- ship between companies and their subsidiaries. Kuhn notes that Spanish telecom firm Telefonica would appear at first glance to be an uncontroversial stock, but it has a media subsidiary which is supposed to have provided access to pornography. Similarly, ESG funds are of limited use when it comes to screening out firms with unethical practices. “Amazon is in most ESG funds which is a surprise because I don’t think they have a good reputation when it comes to how they treat their workers,” Kuhn says.


Sin premia


The attraction of sin stocks is their supposed propensity to produce better returns. Certainly, there is a school of thought that institutional investors like pension funds are constrained to hold less virtuous stocks to produce returns for their mem- bers.


If there’s anything that counts for inclusion in the sin bin, it’s tobacco. Research by Dimson, Marsh and Staunton of the Lon- don Business School shows just what investors would have given up by excluding tobacco from their portfolios. Performance data for 15 US industries back to 1900 shows that the best performer was tobacco, which gave an annualised


Behaviours can be changed but they are not going to be changed by small pension funds.


Mark Hedges, Nationwide Pension Fund


return of 14.6%, and a terminal value of $6.2m (£4.7m), more than 5,000 times as much as shipbuilding and shipping. Yet Derry Pickford, an asset allocation principal consultant at Aon, is sceptical about whether tobacco’s sustained outper- formance is attributable to sin premia, the evidence for which he does not find especially robust. “With all of these analyses of historical returns how much is due to an equilibrium risk factor and how much is just purely a function of luck is highly debateable and people will argue about how you explain those historic returns. “I think we must acknowledge that luck probably played a large part in the outperformance of tobacco stocks since 1900,” he adds. “You wouldn’t anticipate luck to keep on favouring tobacco stocks.” Possibly also undermining the theory that tobacco enjoys a sin premium is the more mundane consideration that in the early 1980s tobacco stocks were cheap, as people didn’t appreciate the sustainability of their profits and were overly concerned about litigation risks. It’s less clear that they are extremely cheap now and that’s even with people divesting because there are others out there who will like the other characteristics of these companies. Notwithstanding the preferences of pension scheme members for virtuous investing in many cases decision-making is out of their hands because pension schemes are invested in passive funds, which come with the additional advantage of having lower fees than their active counterparts. However, there are also quasi-passive indices which investors can track which are tilted towards strong ESG companies. The Nationwide Pension Fund is reducing its equity hold- ings but those it does hold are invested passively. Instead the scheme’s approach has been to urge fund managers to engage with companies in terms of their governance. But ethical con- siderations did play a part in it turning down a fund manager recently.


Reputational risk Hedges says that although the private debt manager would otherwise have been a perfect fit for the fund, it was felt that some of its investments posed too much of a reputational risk for the scheme.


“When we delved into their portfolio of underlying loans and analysed them, we felt somewhat uncomfortable they had an online gambling business and one of their loans was to a business that made electrical equipment for adult services,” Hedges says.


The two things that proved too much for the scheme were the fund manager’s loans, first to a business called gunbroker. com and another to savagearms.com, which sells guns online in the US. This would not prove problematic in the US where


40 | portfolio institutional March 2020 | issue 91


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