Return performance of sin stocks: Evidence from Western European market
Bachelor’s Thesis Santeri Määttänen
Aalto University School of Business Department of Finance
Title of thesis Return performance of sin stocks: Evidence from Western European market
ProgrammeBachelor’s Degree MajorFinance
Thesis advisorJoni Kokkonen
Date3.12.2021 Number of pages22/7 LanguageEnglish
In this paper, I investigate the monthly returns of a portfolio consisting of sin stocks in Western Europe over the period 2000 to 2021 and during the ongoing Covid-19 pandemic. Sin stocks in this paper include companies involved in alcohol, tobacco and gambling industries. I find that the Sin Portfolio – portfolio consisting of sin stocks – provides investors significant abnormal returns over the market portfolio over the long term. Furthermore, I examine the industry returns individually and by excluding each industry from the Sin Portfolio one by one. I find that gambling drives at least partly the returns of the Sin Portfolio as the significance disappears when I exclude gambling stocks from the Sin Portfolio. The Sin Portfolio provides positive but not significant returns during Covid-19. However, I find significant abnormal returns among gambling stocks during the pandemic. Results suggest that gambling stocks drive the returns of the Sin Stock portfolio at least partly.
Keywords Sin stocks, Western Europe, abnormal return, Covid-19
Abstract ... 2
1. Introduction ... 4
2. Literature review ... 6
3. Data ... 8
3.1 Background and selection of sin stocks ... 8
3.2 Market data ...11
3.3 Risk-free rate ...12
4. Methodology and hypotheses ... 12
4.1 Regressions ...12
4.2 Main hypotheses ...14
5. Results ... 15
5.1 Sin Portfolio Performance...15
5.2 Industry portfolios and excluding each industry ...17
5.3 Sin stocks during Covid-19 ...19
6. Conclusions ... 21
References ... 23
Appendix ... 25
Stocks of companies that are participating in producing tobacco, alcohol and gambling are typically called sin stocks. More and more investors avoid stocks that are related to these industries while adopting social screening with their investment decisions. Socially Responsible Investing (SRI) provides investors a way to align their personal values with investment objectives with their concerns about social, environmental and ethical issues (About Sustainable Responsible Impact Investing, 2021). While socially responsible investing and forbearing investment in sin stocks are not the same, sin stocks are usually avoided by socially responsible investors. Investors of sinful stocks believe that the cash flows and stability of these industries provide risk-adjusted abnormal returns over benchmark portfolio (Richey, 2017). Various studies have examined the historical performance of sin stocks and found results that they have delivered significantly positive abnormal results. This investment strategy may originate from Merton’s (1987) “neglected stock”
theory, which suggests that stocks with lower interest among investors are covered by less analysts and therefore provide abnormal returns for investors that invest in these unpopular stocks.
However, he does not state that neglected stocks lack the quality of information, but rather the quantity of information since fewer analysts cover them. Kim and Venkatachalam (2011) examine whether abstaining sin stocks would be explained by greater information risk due to poor financial reporting quality and find out that sin companies’ financial reporting quality is superior related to the benchmark group, implying that the avoidance of investors cannot be attributable to financial reporting factors.
A popular explanation for the abnormal returns of sin stocks is that they are shunned by investors, which makes them systematically underpriced. Hong and Kacperczyk (2006) suggest that there is a social norm against funding businesses that promote vice and that some investors, particularly institutions that are subject to norms, pay a financial cost avoiding these stocks. This phenomenon enables investors that are not norm-constrained to make abnormal positive returns investing in vice industries. In the words of Fabozzi, Ma and Oliphant [2008, pp. 92–93, as cited in Blitz and Fabozzi, 2017], “an economic gain might accrue for not conforming to social standards.” Sin industries could also benefit from monopolistic returns. For instance, the tobacco market is rather oligopolistic since there are only a few major players in the industry, acquiring smaller companies and enjoying the scarcity of competition in the industry.
While there is compelling evidence that sin stocks have provided investors abnormal positive returns over the market portfolio in various markets, the amount of mutual funds focusing on sin stocks is rather low. The Vitium Global Fund started 2002 is the most considerable mutual fund investing investing in sin stocks (Troberg, 2016). The low amount of mutual funds focusing on sin stocks may result from reputation risk that arises from socially irresponsible investing.
In this paper, I examine the abnormal returns of a portfolio constructed by companies in fields of business that are seen as sinful. I use a sample of 10 Western-European countries including Austria, Belgium, Czech Republic, France, Germany, Ireland, Luxembourg, Netherlands, Switzerland and the United Kingdom. To investigate whether the portfolio constructed by sin stocks has provided investors positive abnormal returns over the market portfolio, I use the Capital Asset Pricing Model (Sharpe, 1964; Lintner, 1965), the Fama-French Three-Factor Model (Fama and French, 1992, 1993) and the Carhart Four-Factor Model (Carhart, 1997). For the market portfolio, I use stocks in Western European stock exchanges. Results show that that there are positive abnormal returns in portfolio constructed by sin stocks when controlling with commonly known variables. However, significance disappears when excluding gambling stocks from the Sin Portfolio. Furthermore, I study the performance of sin stock portfolio during the ongoing Covid-19 pandemic. I find slightly positive abnormal returns over the market portfolio, but the results are not significant.
The paper contributes to the existing literature in the following ways. First, abnormal positive returns of sin stocks have not been studied yet in Western Europe. Although previous studies have found evidence of the abnormal positive returns in Europe, I am unaware that there are prior studies of the sin stocks’ performance made in the specific region. Western Europe is an interesting region to study the sin stocks performance since most of the sin stocks are in the United Kingdom, Germany and France. In this region, there is also variety in religious preferences. According to Salaber, (2009) smoking, drinking and gambling are considered in a different way between Catholic and Protestant populations. For instance, while Protestants support strict alcohol and gambling controls, Catholics are hostile to the prohibition of alcohol and gambling. Moreover, Western Europe is one of the richest regions in the world. For example, Germany has the highest GDP in Europe and Luxembourg has the world’s highest GDP per capita. Additionally, Switzerland and Luxembourg have the highest average salary in the world (GDP (current US$) - European Union | Data, 2021). Second, I find no existing literature about how sin stocks have
performed during the Covid-19 pandemic. Prior literature suggests (see. eg. Salaber, 2009) that sin stocks are rather stable against market changes and fairly resistant against recessions. As I am including in my study the most recent data, I can examine how sin stocks have performed during the pandemic. For instance, Grossman et al. (2020) find in their study that alcohol sales in bars, pubs, restaurants and nightclubs collapsed during the beginning of the pandemic due to lockdowns.
On the other hand, alcohol and tobacco consumption has increased in households, with a significant increase in sales in retail or online stores. There has been a similar trend in the gambling industry. Hodgins and Stevens (2021) discuss in their study that various gambling venues such as casinos, horse racing tracks, bars and clubs with electronic gambling machines and gambling retailers were forced to close especially during the first phase “lockdown”. Whereas numerous gambling venues suffered from lockdowns, also sports betting decreased critically during the beginning of the pandemic. However, whereas land-based gambling has decreased online gambling sites have experienced more demand for their services. Authors estimate that online gambling has increased by around 15% during the pandemic and lockdowns.
The rest of the paper is constructed as follows. Section 2 provides a literature review of previous studies related to the subject. In section 3, I describe the data collection and provide the background of sin stocks. Section 4. defines the methodology and main hypotheses. Section 5. Presents the main results of the study and Section 6 concludes.
2. Literature review
Even though an excessive amount of literature exists on Socially Responsible Investing, the amount of literature related to sin stocks and “vice investing” remains limited. However, the results considering the sin stocks are similar proposing that sin stocks have previously provided investors abnormal returns over their benchmark portfolio and they are collectively underpriced since they are shunned by norm constrained investors.
Chong et al. (2006, as cited in Richey, 2017) evaluate in their paper if socially irresponsible investing provides more returns than socially responsible investing. Using traditional performance measures and then applying a generalized autoregressive conditional heteroscedasticity model,
they find that the Vitium Global Fund (formerly Barrier Fund and Vice Fund) outperforms the Domini Social Equity Fund (the benchmark for socially responsible investments) during a three- year period from 2002 to 2005.
In the most cited study about the subject so far, Hong and Kacperczyk (2006) use US data over the period 1965-2006 and find out that their sample of sin stocks outperform their comparable companies by 0.26 percentage after adjusting for Carhart Four-Factor Model. Comparable stocks have similar characteristics to sin stocks while still being virtuous. They consider that society is against funding operations that promote vice and the neglect of these stocks by large institutional investors causes sin stocks to be underpriced. Their results also show that stocks in sin industries gain less coverage from analysts than stocks with similar traits. However, they find no relationship between sin stocks’ returns and litigation risk even though it is suggested that sin stocks generate higher returns to compensate for the higher risk of lawsuits due to the nature of the industry.
Researchers determine that the sin stocks’ positive abnormal returns are due to norm-constrained investors neglecting firms in sin industries.
In another study, Salaber (2009) examines the sin stocks performance in the European market using data on 18 countries over the period 1975-2006. She explores stocks returns depending on sample countries’ religious preferences and finds out that Protestants are more sin averse than Catholics, requiring more return premium on sin stocks. Her results also show that sin stocks have higher risk-adjusted returns if they are located in countries with high excise taxation. Moreover, contrary to Hong and Kacperczyk’s (2006) results, she finds that sin stocks outperform other stocks when litigation risk is higher, even after controlling for commonly known variables such as SMB and HML.
In a more recent study, Troberg (2016) studies the return of sin stocks on European markets in a period 1985-2016, adding the defense industry to the sin stock analysis. Her results show that a portfolio long on sin stocks earns statistically significant positive abnormal returns over the market return, even after adopting Carhart Four-Factor Model to the regression. In contrary to Hong and Kacperczyk (2006), she does not find significant results that sin stocks outperform their comparables. Salaber (2009) finds supportive results in her study over the US market, as the excess return of sin stocks disappears when she compares sin stocks to a portfolio with similar defensive characteristics.
Richey (2017) investigates the return performance of 65 US sin stocks over the period 1996 to 2016 and finds that significance of abnormal positive returns disappears when using the Fama- French Five-Factor Model, in which there are added two novel quality factors – profitability and investment – in commonly known Fama-French Three-Factor Model. Results of the study indicate that sin stocks yield higher returns since they are more profitable and invest in their business more aggressively than a regular corporation. Blitz and Fabozzi (2017) find similar results as they study sin stocks’ returns with Five-Factor Model on various markets globally. Additionally, their results show that there are no significant positive abnormal results in Japanese stock markets – CAPM alpha is not even significant, to begin with.
As I am examining how the sin stocks have performed during the Covid-19 pandemic, I am interested in how these stocks have performed during previous recessions and market fluctuations.
Salaber (2009) examines the US stock market and finds that sin stocks outperform during the bear market but underperform during the bull market. Troberg (2016) finds supporting evidence by examining the single-factor CAPM betas finds that the sin stocks are rather stable against the market fluctuations. Moreover, her results show that sin stocks are quite resistant against recessions and recover rapidly from sinking markets. Both authors suggest that the defensive nature of sin stocks may stem from their addictive traits.
3.1 Background and selection of sin stocks
Various industries are treated as if they include sin companies. Therefore, it is essential to define what is sin stock. The commonly known websiteInvestopedia defines sin stocks as follows: “A sin stock is a publicly-traded company involved in or associated with an activity that is considered unethical or immoral. Sin stocks are generally in sectors that deal directly with morally dubious actions. They are perceived as making money from exploiting human weaknesses and frailties.”
There are various industries, such as the defense industry, that are accounted as sinful or unethical from some group’s point of view. However, each investor has their own definitions of sinful which may include only proportion or every stock. Thus, my analysis of sin stocks focuses on the industry
group known as the “Triumvirate of Sin”, which includes alcohol, tobacco and gambling. One commonly added industry related to sin stocks is the defense industry. For instance, the Vitium Global Fund – a mutual fund investing entirely in sin stocks - has a defense industry in its portfolio in addition to alcohol, tobacco and gambling. However, as the defense industry does not share the same traits as other sin industries, I will not add it to my analysis. Firstly, according to Salaber, (2009) the defense sector across Western Europe includes various companies with broad product or service portfolios and therefore it is difficult to define these companies. Second, alcohol and tobacco consumption, as well as gambling are collectively considered as sinful activities that have a significant burden to society, whereas the defense industry is seen even essential on some occasions. Third, alcohol, drinking and gambling all inflict addictive behavior, causing high external costs in terms of healthcare and having limited substitutes. Other industries that are considered sinful include crime, marijuana and payday loan industries. These companies are not added to my analysis as there are little to no public companies in these fields of business.
It is important to note that what is seen as a sin stock can change over time. Companies defined as sin stocks can change their product mix or revenue sources that can lead to reclassification. For instance, Blitz and Fabozzi (2017) discuss in their paper that Heineken and Anheuser Bush have announced plans to aggressively promote their non-alcoholic beer. The shift can also be contrary as tobacco was initially treated as an effective medicine. This was because the health consequences of tobacco were not generally known until the 1960s when there was a released report that tobacco causes lung cancer.
From the Western-European countries, I pick all tobacco industry companies, alcohol beverage companies and gambling companies, which are listed in exchange during the period. To identify the sin companies in my sample, I use the Fama French (1997) classification of stocks based upon their Standard Industrial Classification (SIC) codes into 48 industries. SIC codes are four-digit numerical codes that categorize the industries that companies belong to depending on their business activities (Investopedia). Alcoholic Beverages are under the SIC codes 2080-2085 while tobacco products are under codes 2100-2199. There are no SIC codes for gambling or casino industries but according to Troberg (2016) they are usually categorized as 7999 “Miscellaneous entertainment”. To identify the gambling stocks, I use Datastream’s industrial classification
“Casinos & Gambling” and find that most of them are categorized under SIC code 7999.
Over the entire period, there are 172 sin stocks distributed as follows: 97 stocks belong to the alcohol sector, including brewers Heineken and Anheuser-Busch InBev which own well-known brands such as Sol and Budweiser, as well as distilleries and vintners, like Pernod-Ricard and Diageo, owner of some of the world’s most famous drink brands, such as Captain Morgan and Smirnoff Vodka; 6 stocks belong to tobacco sector, including tobacco manufacturers such as British American Tobacco, who owns familiar brands such as Pall Mall and Northstate; 69 stocks in gambling industry including firms such as The Société des Bains de Mer, which owns multiple casinos and hotels including Casino de Monte Carlo in Monaco and gambling companies providing online-betting services such as Entail and Flutter Entertainment. A low number of tobacco stocks is due to the oligopolistic nature of the tobacco industry - there are only a few major players that dominate the industry - and in Western European countries these companies either have long- established dominance or have acquired the main domestic producers.
A low number of sin stocks is because of the fact many of the sin companies are not public. All 172 stocks are not present at the same time in the study. Table 1 shows industry-specific distribution each year. The table shows that there has been decreasing trend in the number of sin stocks, which can be due to major players acquiring smaller companies. The most sin stocks are in the United Kingdom, Germany and France. A list of companies is presented in Appendix A.
Table 1. Distribution of sin stocks by year
Year Alcohol Tobacco Gambling Total
2000 82 6 16 104
2001 80 6 18 104
2002 80 6 18 104
2003 74 6 18 98
2004 67 5 23 95
2005 65 5 30 100
2006 60 5 33 98
2007 57 5 34 96
2008 58 4 34 96
2009 54 4 34 92
2010 53 4 35 92
2011 48 3 35 86
2012 45 3 33 81
2013 47 3 28 78
2014 48 3 29 80
2015 48 3 27 78
2016 46 3 26 75
2017 43 3 25 71
2018 42 3 21 66
2019 41 3 20 64
2020 38 3 19 60
2021 38 3 16 57
3.2 Market data
I obtain my data from Thomson Reuters Datastream. I include in my market sample all common stocks from the following 10 countries located in Western Europe: Austria, Belgium, Czech Republic, France, Germany, Ireland, Luxembourg, Netherlands, Switzerland and United Kingdom. Two Western-European countries have been removed from the sample (Liechtenstein and Monaco) because there are no publicly traded companies for these countries. From the sample, I exclude financial companies since they are constrained by strict regulation and these industries differ significantly from other industries. I also exclude stocks that have no available data during the period. I include in the sample the companies that disappear during the period. Disappeared stocks are either delisted, defaulted or merged. Thus, the data is free of survivorship bias. After cleaning the dataset, I have a sample of 7015 stocks across the Western European countries, over 261 months. From the companies, I retrieve the monthly return index, market capitalization and price-to-book value (inverse of book-to-market). Return index shows theoretical growth in value, assuming that dividends are reinvested to purchase additional units of equity at the closing price applicable on the ex-dividend date. Additionally, return index takes into consideration stock splits.
Market values are obtained in the euro rate to avoid any currency effects. I ignore transaction and brokerage costs in my analysis, following the same practice as prior studies.
3.3 Risk-free rate
For risk-free rate I follow Troberg’s (2016) practice and use a 10-year government bond of Germany. Germany can be considered economically as the most reliable country in Western Europe. To use the German interest rate, I must assume that there is no country risk. I test my results using several Western European interest rates and the results stay unchangeable. I consider the German bond’s monthly yield-to-maturity to be an appropriate estimate for Western-European risk-free rate because of Germany’s financial stability and the robustness of results when using other countries’ interest rates.
4. Methodology and hypotheses
Capital Asset Pricing Model
I start with the Capital Asset Pricing Model (Sharpe, 1964; Lintner, 1965) using regression 𝑃𝑡 = 𝛼+𝛽𝑀𝐾𝑇𝑡 +𝜀𝑡
WhereP is the excess return of a value-weighted portfolio consisting of sin stocks excess risk-free rate and 𝑀𝐾𝑇 is the excess return of avalue-weighted market portfolio consisting of Western European stocks. 𝜀𝑡 is an error term. 𝛼 is representing the abnormal returns of the sin stock portfolio compared to market portfolio.𝛽 expresses how volatile sin portfolio is compared to the market portfolio.
Fama-French 3-Factor Model
Additionally, I use Fama-French Three-Factor Model (Fama and French, 1992, 1993) 𝑃𝑡 = 𝛼+𝛽1𝑀𝐾𝑇𝑡 +𝛽2𝑆𝑀𝐵𝑡+𝛽3𝐻𝑀𝐿𝑡 +𝜀𝑡
which adds two commonly known controlling variables to the regression; Small Minus Big (SMB) and High Minus Low (HML). According to Kenneth R. French - Data Library (2021), Fama- French factors are constructed using the six value-weight portfolios of market portfolio formed on size and book-to-market. Portfolios are created by first, dividing stocks 50-50 based on their market capitalizations to get a portfolio of Small Stocks and Big Stocks, and then dividing into three book-to-market groups – low, medium and high – with breakpoint being 30th and 70th percentiles based on their book-to-market ratios. Thus, creating six portfolios I can form two value- weighted portfolios SMB and HML. High book-to-market implies value stock and low book-to- market growth stock. SMB is the difference of returns between the small portfolios and big portfolios,
3(𝑆𝑚𝑎𝑙𝑙 𝑉𝑎𝑙𝑢𝑒+𝑆𝑚𝑎𝑙𝑙 𝑁𝑒𝑢𝑡𝑟𝑎𝑙+𝑆𝑚𝑎𝑙𝑙 𝐺𝑟𝑜𝑤𝑡ℎ)−1
3(𝐵𝑖𝑔 𝑉𝑎𝑙𝑢𝑒+𝐵𝑖𝑔 𝑁𝑒𝑢𝑡𝑟𝑎𝑙+𝐵𝑖𝑔 𝐺𝑟𝑜𝑤𝑡ℎ)
HML is the difference of returns between the two value portfolios and two growth portfolios,
2(𝑆𝑚𝑎𝑙𝑙 𝑉𝑎𝑙𝑢𝑒+𝐵𝑖𝑔 𝑉𝑎𝑙𝑢𝑒)−1
2(𝑆𝑚𝑎𝑙𝑙 𝐺𝑟𝑜𝑤𝑡ℎ+𝐵𝑖𝑔 𝐺𝑟𝑜𝑤𝑡ℎ)
𝛽 in the equation denote the loadings of other portfolios that are used to predict returns of sin stock portfolio.
Carhart 4-Factor Model
Furthermore, I add one more factor in the model to use Carhart Four-Factor Model (Carhart, 1997)
𝑃𝑡 = 𝛼+𝛽1𝑀𝐾𝑇𝑡 +𝛽2𝑆𝑀𝐵𝑡+𝛽3𝐻𝑀𝐿𝑡 +𝛽4𝑀𝑂𝑀𝑡+𝜀𝑡
Momentum (MOM) factor is constructed using the six value-weight portfolios of the market portfolio formed on size and previous 12-month returns. According to Kenneth R. French - Data Library (2021), portfolios are created by first dividing stocks 50-50 based on their market capitalizations to get a portfolio of Small Stocks (S) and Big Stocks (B), and then dividing into three groups – low-return (L), medium-return (M) and high-return (H) – with breakpoint being 30th and 70th percentiles based on the past 12-month returns of a stock. Thus, by creating six portfolios, SL, SM, SH, BL, BM and BH, I can form MOM portfolio.
MOM is the difference of returns between the highest 30% return portfolios and lowest 30% return portfolios,
2(𝑆𝑚𝑎𝑙𝑙 𝐻𝑖𝑔ℎ+𝐵𝑖𝑔 𝐻𝑖𝑔ℎ)−1
2(𝑆𝑚𝑎𝑙𝑙 𝐿𝑜𝑤+𝐵𝑖𝑔 𝐿𝑜𝑤)
I use monthly data from January 2000 to September 2021 in the regressions, but I also examine the data during the ongoing Covid-19 pandemic. I add dummy variable to regression that takes a value of one during pandemic from period February 2020 to September 2021 and zero otherwise.
𝑃𝑡 = 𝛼+𝛽1𝑀𝐾𝑇𝑡 +𝛽2𝑆𝑀𝐵𝑡+𝛽3𝐻𝑀𝐿𝑡 +𝛽4𝑀𝑂𝑀𝑡+𝛽5𝐶𝐷𝑈𝑀𝑡+𝜀𝑡
Finally, I perform regressions on each industry to further understand the characteristics and performance of each field of business. I also exclude industries from the sin stock portfolio one by one to examine if the abnormal returns are driven by one specific industry.
4.2 Main hypotheses
By studying the prior literature and especially the similar study conducted by Troberg (2016) in the European market, I hypothesize that sin stocks provide investors positive abnormal results over the market portfolio. I examine the first hypothesis by conducting a time-series regression based on the Capital Asset Pricing Model, the Fama-French Three-Factor Model and the Carhart Four- Factor Model. I use the value weighted returns of a sin portfolio excess the risk-free rate and the value weighted returns of a benchmark portfolio net risk-free rate, which includes stocks in the Western European market.
By examining previous literature about the essence of sin stocks, I find that sin industries are quite stable against recessions and due to their addictive traits and other characteristics shared in the sin industries. Thus, my second hypothesis is that sin stocks have provided investors abnormal returns over the period of the Covid-19 pandemic. I examine my second hypothesis using Carhart Four-
Factor Model. Studying the literature of sin industries’ market conditions during the Covid-19 pandemic I estimate that sin stocks have overall benefitted from the pandemic.
5.1 Sin Portfolio Performance
This section examines the results obtained from time-series regressions of portfolios consisting of sin. I begin by performing series of regressions for the Sin Portfolio (the excess monthly return of a value-weighted portfolio consisting of alcohol, tobacco and gambling stocks). By performing regressions using the Capital Asset Pricing Model, the Fama-French Three-Factor Model and the Carhart Four-Factor Model, I test my hypothesis and examine whether the Sin Portfolio has provided abnormal positive returns over the period from 2000 to 2021.
Results of the first estimation based on Capital Asset Pricing Model are shown in Table 2. The first estimation shows the excess monthly return of value-weighted Sin Portfolio over the excess monthly return of a value-weighted market portfolio. Results show that the alpha coefficient is 0.43 percentage points monthly implying the abnormal returns over the market portfolio. Alpha is significant at 5% confidence level. Market beta measures how sin stock portfolio moves when the overall stock market increases or decreases. Beta is 0.69, which is significant at 1% confidence level, implying that the Sin Portfolio is less sensitive compared to the overall stock market.
The second estimation is based on Fama-French Three-Factor Model and results are shown in Table 2. The second estimation presents the monthly return of Sin Portfolio over the market portfolio and two other portfolios – SMB and HML. Results show that when two factors are added, alpha coefficient is slightly lower in the second regression at 0.42 percentage points, which is still significant at 5% confidence level. SMB coefficient is -0.17, significant at 10% confidence level, signaling that the Sin Portfolio is slightly weighted towards stocks with high market capitalization.
HML coefficient is not significant, implying that Sin Portfolio is not considerably loaded with either value or growth stocks.
The third estimation is based on Carhart Four-Factor Model presented in Table 2. In the third estimation, I add MOM to the regression. Four-Factor alpha is 0.40 percentage points, which stays significant at 5% confidence level. MOM is 0.08 which is significant at 10% confidence level, implying that Sin Portfolio is slightly weighted toward stocks that have performed better than the overall market.
Table 2. Sin Portfolio Regressions: 2000-2021
Notes: The table reports coefficients obtained from the time-series regressions of the Sin Portfolio (the excess monthly return of a value-weighted portfolio of sin stocks – alcohol, tobacco and gambling).t-statistics are in parentheses.
Each regression is estimated using monthly data for the period from January 2000 to September 2021. I estimate the coefficients with Capital Asset Pricing Model (i), Fama-French Three-Factor Model (ii) and Carhart Four-Factor Model (iii).ALPHA is the abnormal return over the market portfolio.MKTis the excess monthly return of the value- weighted market portfolio consisting of Western-European stocks.SMB is the return of a portfolio long small market capitalization stocks and short large market capitalization stocks.HML is the return of a portfolio long high book-to- market stocks and short low book-to-market stocks.MOM is the return of a portfolio long past 12-month highest return and short past 12-month lowest return.*** significant at 1%; ** significant at 5%; * significant at 10%.
(i) (ii) (iii)
ALPHA 0.0043** 0.0042** 0.0040**
(2.27) (2.01) (1.96)
MKT 0.69*** 0.69*** 0.72***
(16.49) (16.47) (16.03)
SMB -0.17* -0.19**
HML 0.015 0.06
R-square 0.51 0.52 0.52
Observations 260 260 260
The main finding in Table 2 is that in the estimations, alpha coefficient ranges between 0.40 and 0.43 percentages, which are all significant at the 5% confidence level. Significant results of alpha are in harmony with previous findings that suggest sin stocks outperform the market. Market beta ranges between 0.69 and 0.72 which is significant in all models at 1% level, showing that the Sin Portfolio is less volatile than the market portfolio, which has beta equal to one. Beta less than one
is typical in sin industries which are stated to be defensive. However, it is notable that the percentage of alcohol stocks in the Sin Portfolio is higher than other industries during the period.
R-squared remains at an appropriate level at around 51% in all models.
5.2 Industry portfolios and excluding each industry
In this section, I examine the characteristics of sin industries individually. I estimate regressions using the Carhart Four-Factor Model. I perform the regression for each value-weighted industry portfolio (Alcohol Portfolio, Tobacco Portfolio, Gambling Portfolio) separately and excluding each industry from the Sin Portfolio one by one. I estimate industries separately to further understand the characteristics and performance of each field of business. Excluding each industry one by one is essential to notify if there are industries that drive the results of the Sin Portfolio.
Results of regressions are shown in Table 3 below.
I begin by examining abnormal returns of each industry portfolio. Each industry portfolio has positive alpha coefficient, which implies that each industry has outperformed the market portfolio, stocks of Western Europe. Whereas there are no significant abnormal returns in Alcohol or Tobacco portfolios, Gambling returns 1.2 percentage points, which is significant at 1% level.
Results show that gambling has provided significant returns over the market portfolio and compared to other industries during the past two decades. Each industry returns market beta significant at 1% ranging from 0.64 to 0.78. Results suggest that each industry is less volatile than the overall market. Tobacco and Gambling portfolios have SMB coefficients of -0.45 and 0.63, respectively. Both results are significant at 1% level. Results imply that the Tobacco portfolio is considerably weighted towards stocks with high market capitalization. This is concordant in the real world since there are only a few major players in the tobacco industry who dominate the market and have acquired smaller companies. Gambling also shows HML coefficient of -0.25 which is significant at 1% level. This would imply that the portfolio is weighted towards stocks with low book-to-market ratio i.e., growth stocks.
I am also interested in how the results occur as I exclude each sin industry from Sin Portfolio one by one. Interestingly, whereas alpha is positive in each portfolio, it is not significant anymore after excluding gambling stocks from the Sin Portfolio. Results suggest that gambling stocks’ returns
are driving the Sin Portfolio’s performance at least partly, which is somewhat contradictory to previous studies. However, gambling stocks’ share in Sin Portfolio is rather small, as the alcohol stocks have the most substantial weight in the portfolio. Market betas range from 0.68 to 0.74 which are all significant at 1%, suggesting that each industry is considerably less volatile compared to the market portfolio.
Table 3. Industry specific regressions and Excluded industries: 2000-2021
Notes: The table reports coefficients obtained from the time-series regression of the excess monthly return of each industry portfolio (value-weighted portfolio of alcohol, tobacco or gambling) and return of the Sin Portfolio when industries are excluded one by one from the portfolio. For instance, ExcAlcohol is the Sin Portfolio excluding alcohol stocks.t-statistics are in parentheses. Each regression is estimated using monthly data for the period from January 2000 to September 2021. I estimate the coefficients with Carhart Four-Factor Model.ALPHA is the abnormal return over the market portfolio.MKTis the excess monthly return of the value-weighted market portfolio consisting of Western-European stocks.SMB is the return of a portfolio long small market capitalization stocks and short large market capitalization stocks.HML is the return of a portfolio long high book-to-market stocks and short low book-to- market stocks.MOM is the return of a portfolio long past 12-month highest return and short past 12-month lowest return.*** significant at 1%; ** significant at 5%; * significant at 10%.
Alcohol Tobacco Gambling ExcAlcohol ExcTobacco ExcGambling ALPHA 0.0035 0.0039 0.012*** 0.0056** 0.0044** 0.0034
(1.54) (1.14) (3.83) (1.98) (2.07) (1.56)
MKT 0.74*** 0.64*** 0.78*** 0.68*** 0.74*** 0.71***
(14.72) (8.54) (11.61) (10.92) (16.15) (14.96)
SMB -0.16 -0.45*** 0.63*** -0.23* -0.10 -0.24**
(-1.58) (-2.92) (4.61) (-1.82) (-1.09) (-2.46)
HML 0.06 0.18 -0.25** 0.051 0.026 0.087
(0.77) (1.49) (-2.37) (0.52) (0.35) (1.15)
MOM 0.042 0.18** -0.18** 0.14** 0.031 0.09*
(0.79) (2.25) (-2.43) (2.13) (0.63) (1.74)
R-square 0.49 0.24 0.45 0.33 0.54 0.49
Observations 260 260 260 260 260 260
5.3 Sin stocks during Covid-19
I use the Carhart Four-Factor Model to perform time-series regressions of portfolios consisting of stocks in sinful industries during the Covid-19 pandemic. I add a dummy variable to regression model, that equals one during the Covid-19 pandemic period from February 2020 to September 2021 and zero otherwise. I examine the results of the Sin Portfolio and each sin industry separately.
Results of the regressions are shown in Table 4 below.
To test my second hypothesis that states sin stocks have provided investors abnormal returns over the period of the Covid-19 pandemic, my main interest is in the alpha coefficient. All portfolios returned positive alpha, although neither the Sin, Alcohol nor Tobacco Portfolio show significant results. Gambling Portfolio has alpha of 0.94 percentage points, which is significant at 1%
confidence level. Portfolios have beta ranging from 0.63 to 0.75, which are all significant at 1%, implying that each industry has been less volatile than the overall market during the pandemic.
Tobacco and Gambling Portfolios’ SMB coefficients are -0.46 and 0.61, respectively. Both results are significant at 1% level.
Results suggest that sin stocks have provided abnormal returns during the pandemic in some industries. While the other portfolios have no significant returns over the market portfolio, the Gambling portfolio has highly significant abnormal returns. Results, along with studies suggest that the gambling industry has benefitted from the pandemic in their operations. Hodgins and Stevens (2021) discuss in their study that while for instance sport betting and variety of land-based gambling operations have suffered due to restrictions such as lockdowns to avoid the spread of the coronavirus, at the same time online gambling has increased by around 15%. Overall, the companies have low beta, which indicates that each industry is less volatile than the market portfolio, consisting of Western-European stocks. Results are in line with previous literature (see eg. Salaber, 2009; Troberg, 2016) and reinforce the defensive characteristics of sin industries. The defensive nature of sin stocks might be due to addictive traits of products and services that sin industries provide.
Table 4. Sin Regressions Covid-19
Notes: The table reports coefficients obtained from the time-series regressions of a Sin Portfolio (the excess monthly return of a value-weighted portfolio of sin stocks – alcohol, tobacco and gambling) and each sin industry separately.t-statistics are in parentheses. Regression is estimated using monthly data for the period from January 2000 to September 2021. I estimate the coefficients Carhart Four-Factor Model.ALPHA is the abnormal return over the market portfolio.MKT is the excess monthly return of the value-weighted market portfolio consisting of Western-European stocks.SMB is the return of a portfolio long small market capitalization stocks and short large market capitalization stocks.HML is the return of a portfolio long high book-to-market stocks and short low book-to-market stocks.MOM is the return of a portfolio long past 12- month highest return and short past 12-month lowest return.CDUM is a dummy variable that equals one during the Covid-19 pandemic period from February 2020 to September 2021 and zero otherwise. ***
significant at 1%; ** significant at 5%; * significant at 10%.
Sin Alcohol Tobacco Gambling
ALPHA 0.0033 0.0032 0.0032 0.0094***
(1.54) (1.30) (0.87) (2.90)
MKT 0.71*** 0.73*** 0.63*** 0.75***
(14.72) (14.36) (8.28) (11.10)
SMB -0.20 -0.17 -0.46*** 0.61***
(-1.58) (-1.61) (-2.95) (4.43)
HML 0.064 0.064 0.18 -0.23**
(0.77) (0.80) (1.53) (-2.19)
MOM 0.08 0.042 0.18** -0.18**
(0.79) (0.78) (2.25) (-2.44)
CDUM 0.007 0.004 0.007 0.023**
(0.99) (0.45) (0.59) (2.18)
R-square 0.53 0.49 0.24 0.46
Observations 260 260 260 260
In this study, I have examined whether sin stocks in alcohol, tobacco and gambling industries have provided investors abnormal positive returns in Western Europe. I estimate the returns with Capital Asset Pricing Model, Fama-French Three-Factor Model and Carhart Four-Factor Model and find that the Sin Portfolio returns have a positive alpha during the period 2000-2021. The findings show that the Sin Portfolio returns 0.40% monthly after controlling with commonly known variables SMB, HML and MOM. Furthermore, I examine the industry returns individually and by excluding each industry from the Sin Portfolio one by one and find that gambling drives at least partly the returns of the Sin Portfolio. Although the share of gambling stocks is rather small in the Sin Portfolio, excluding these stocks results in the disappearance of significant abnormal returns of the Sin Portfolio. Results suggesting that gambling stocks drive the returns are somewhat contradictory to previous research since Troberg’s (2016) results show that significant abnormal returns do not disappear when excluding gambling stocks from the Sin Portfolio. Additionally, I employ Carhart Four-Factor Model to study the returns of the Sin Portfolio during the ongoing Covid-19 pandemic. I find positive but not significant alpha for the Sin Portfolio during the pandemic. I also inspect each industry during the pandemic and find that only the gambling industry has significant alpha, at 1% level. Results suggest that sin stocks ex. gambling has not provided significantly abnormal results during the pandemic. Inspecting relatively low market betas of the Sin Portfolio and each industry portfolio (alcohol, tobacco and gambling) separately, I find that sin industries possess defensive characteristics. Previous literature has found supportive evidence, as Troberg (2016) shows that sin stocks are quite resistant against recessions and recover rapidly from sinking markets. Salaber (2009) examines the US stock market and finds that sin stocks outperform during the bear market but underperform during the bull market. Prior literature suggests that the defensive characteristics of sin stocks might arise from their addictive traits.
The results provide further evidence on the outperformance of sin stocks and that the phenomena occur broadly in various market areas. Whereas there are studies from the US (eg., Hong and Kacperczyk, 2006; Richey, 2017) and the whole of Europe (eg., Troberg, 2016; Salaber, 2009), I examine specific region including countries in Western-Europe and find that results stay similar.
Interestingly, outperformance of sin stocks is a long term phenomenon and although it has been known in prior studies for over a decade, the markets have not corrected it, which violates the
efficient market hypothesis. A popular explanation for the abnormal returns of sin stocks is that they are shunned by investors, which makes them systematically underpriced. Investing in sin stocks might cause reputation risk to investors. Hong and Kacperczyk (2006) suggest that there is a social norm against funding businesses that promote vice and that some investors, particularly institutions that are subject to norms avoid these stocks. Merton’s (1987) “neglected stock” theory suggests that stocks with lower interest among investors will be covered by fewer analysts and therefore provide abnormal returns for investors. As Socially Responsible Investing (SRI) is gaining popularity and investors are more self-conscious of their investment decisions, the demand for irresponsible investments is potentially decreasing. Troberg (2016) finds that there is a positive correlation between the money invested in SRI funds and returns of the sin stock. An interesting aspect for future research is to see how the increasing popularity of SRI investing will affect the returns of sin stocks.
Even though the sin stocks provide services and products that have harmful effects for society and are considered unethical, these companies do not generally operate unethically. For instance, Cai et al. (2011) argue that US companies in sin industries consider corporate social responsibility essential in their operations although they provide harmful products or services. Furthermore, Kim and Venkatachalam (2011) find that sin companies’ financial reporting quality is superior related to their benchmark group. It is important to note that what is seen as a sin stock can change over time. While companies defined as sinful can change their product mix or revenue sources that can lead to reclassification, the shift can also be contrary. As norms and values change, the definition of sin industries can also change.
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Appendix A: List of Companies
No. Name Industry Country
1 32Red Gambling United Kingdom
2 365 Media Group Gambling United Kingdom
3 888 Holdings Gambling United Kingdom
4 Actris Alcohol Germany
5 Admiral Sportwetten Gambling Austria
6 Adnams 'B' Alcohol United Kingdom
7 Advini Alcohol France
8 Aktien Brau.Kaufbeuren Alcohol Germany
9 Allgaeuer Brauhaus Alcohol Germany
10 Allied Domecq Alcohol United Kingdom
11 Amz Holdings Gambling United Kingdom
12 Anheuser-Busch Inbev Alcohol Belgium
13 Ann Street Gp. Alcohol United Kingdom
14 Asianlogic (Di) Gambling United Kingdom
15 Aspinalls Online Gambling United Kingdom
16 B90 Holdings Gambling United Kingdom
17 Bains Mer Monaco Gambling France
18 Bayer.Brauholding Alcohol Germany
19 Bayreuther Bierbrauerei Alcohol Germany
20 Bbag Oest.Brau Alcohol Austria
21 Belhaven Group Alcohol United Kingdom
22 Berentzen-Gruppe Pref. Alcohol Germany
23 Berliner Kindl Brauerei Alcohol Germany
24 Bet-At-Home.Com Gambling Germany
25 Betex Group Gambling United Kingdom
26 Betfair Group Gambling United Kingdom
27 Betonsports Gambling United Kingdom
28 Betonusa Gambling Germany
29 Blaue Quellen Alcohol Germany
30 Boisset Alcohol France
31 Brau Und Brunnen Alcohol Germany
32 Brau-Union Alcohol Austria
33 British American Tobacco Tobacco United Kingdom
34 Brouwerij - Handelsmaatschappij Alcohol Belgium
35 Buerg.Brauh.Ravsbg.Lind. Alcohol Germany
36 Bulmer (Hp) Alcohol United Kingdom
37 Burn Stew.Dists. Alcohol United Kingdom
38 Bwin Intact.Entm. Gambling Austria
39 Bwin Party Digital Entm. Gambling United Kingdom
40 C&C Group (Dub) Alcohol United Kingdom
41 Cains Beer Company Alcohol United Kingdom
42 Chamarre Alcohol France
43 Chapel Down Group Alcohol United Kingdom
44 Cosentino Signt.Wines Alcohol United Kingdom
45 Cottin Freres Alcohol France
46 Cubus Lux Gambling United Kingdom
47 Diageo Alcohol United Kingdom
48 Dic Bereilig U Immob. Alcohol Germany
49 Dinkelacker Alcohol Germany
50 Diosos Alcohol France
51 Distil Alcohol United Kingdom
52 Dm Gambling United Kingdom
53 Dom-Brauerei Alcohol Germany
54 Dortmund Act-Brauer Alcohol Germany
55 Duvel Moortgat Alcohol Belgium
56 Eichbaum-Brauereien Alcohol Germany
57 Einbecker Brauhaus Alcohol Germany
58 Entain Gambling United Kingdom
59 Europeenne Casinos Gambling France
60 Fairground Gaming Hdg. Gambling United Kingdom
61 Fevertree Drinks Alcohol United Kingdom
62 Flutter Entertainment Gambling Ireland
63 Fortuna Entm.Group Gambling Netherlands
64 Fun Technologies Gambling United Kindgom
65 Gallaher Group Tobacco United Kingdom
66 Gamesys Group Gambling United Kingdom
67 Gaming Realms Gambling United Kingdom
68 Gilde Brauerei Alcohol Germany
69 Glenmorangie 'A' Alcohol United Kingdom
70 Grand Marnier Alcohol France
71 Grolsch (Kon.) Alcohol Netherlands
72 Groupe Partouche Gambling France
73 Gurktaler S Alcohol Austria
74 Gusbourne Alcohol United Kingdom
75 Hbw Abwicklungs Alcohol Germany
76 Heineken Alcohol Netherlands
77 Heineken Holding Alcohol Netherlands
78 Henri Maire Alcohol France
79 Highlight Event & Entm. Gambling Switzerland
80 Holsten-Brauerei Alcohol Germany
81 Holt (Joseph) Alcohol United Kingdom
82 Hotels Deauville Gambling France
83 Icn Immobilien Consult Alcohol Germany
84 Imperial Brands Tobacco United Kingdom
85 Innstadt-Brauerei Alcohol Germany
86 Inspired Gaming Group Gambling United Kingdom
87 Interactive Gaming Hdg. Gambling United Kingdom
88 Jennings Brothers Alcohol United Kingdom
89 Kindred Group Sdr Gambling United Kingdom
90 Kulmbacher Brauerei Alcohol Germany
91 Kunick Gambling United Kingdom
92 Kupferberg Alcohol Germany
93 La Francaise Des Jeux Gambling France
94 Ladbrokes Coral Group Gambling United Kingdom
95 Lanson-Bcc Alcohol France
96 Laroche Alcohol France
97 Laurent Perrier Alcohol France
98 Leisure & Gaming Gambling United Kingdom
99 Loewenbraeu Alcohol Germany
100 Lombard Et Medot Alcohol France
101 London Clubs Intl. Gambling United Kingdom
102 Lotto24 K Gambling Germany
103 Lovely Bubbly Holdings Alcohol United Kingdom
104 Lucasbols Alcohol Netherlands
105 Malteries F-Belges Alcohol France
106 Marie Brizard Alcohol France
107 Mbws Alcohol France
108 Merrydown Alcohol United Kingdom
109 Mnz.Akt.-Bierbrau Pref. Alcohol Germany
110 Moninger Holding Alcohol Germany
111 Mybet Holding Gambling Germany
112 Nektan Gambling United Kingdom
113 Netplay Tv Gambling United Kingdom
114 Newbury Racecourse Gambling United Kingdom
115 Northern Racing Gambling United Kingdom
116 Oppmann Immobilien Alcohol Germany
117 Ottakringer Getrdnke Pf. Alcohol Austria
118 Park & Bellheimer Alcohol Germany
119 Pernod-Ricard Alcohol France
120 Pferdewetten De N Gambling Germany
121 Philip Morris Cr Tobacco Czech Republic
122 Pine Ventures Gambling United Kingdom
123 Pivovar Radegast Delisted 01/10/02 Alcohol Czech Republic
124 Pivovary Lobkowicz Group Alcohol Czech Republic
125 Playjack Gambling Germany
126 Playtech Gambling United Kingdom
127 Pol-Roger Et Compagnie Limited Data Alcohol France
128 Praesepe Gambling United Kingdom
129 Prazske Pivovary Alcohol Czech Republic
130 Probability Gambling United Kingdom
131 Quilmes Industrial Alcohol Luxembourg
132 Radeberger Gruppe Alcohol Germany
133 Rank Group Gambling United Kingdom
134 Raphael Michel Alcohol France
135 Remy Cointreau Alcohol France
136 Sabmiller Alcohol United Kingdom
137 Sc.Fme.Du_Cno.De_Cannes Gambling France
138 Sceptre Leisure Gambling United Kingdom
139 Schloss Wachenheim Alcohol Germany
140 Schlumberger Alcohol Austria
141 Scottish & Newcastle Alcohol United Kingdom
142 Seguin Moreau Alcohol France
143 Seita Tobacco France
144 Shepherd Neame 'A' Alcohol United Kingdom
145 Soboa Alcohol France
146 Societe Fse.De Casinos Gambling France
147 Socopi Tobacco France
148 Sportech Gambling United Kingdom
149 Sportingbet Gambling United Kingdom
150 Sports Internet Group Gambling United Kingdom
151 Stadlauer Malzfabrik Alcohol Austria
152 Stanley Leisure Gambling United Kingdom
153 Stinag Stuttgart Invest Alcohol Germany
154 Stock Spirits Group Alcohol United Kingdom
155 Stride Gaming Gambling United Kingdom
156 Taittinger Alcohol France
157 Talarius Gambling United Kingdom
158 The Artisanal Spirits Company Alcohol United Kingdom
159 Thwaites (Daniel) Alcohol United Kingdom
160 Tintra Gambling United Kingdom
161 Top Ten Holdings Gambling United Kingdom
162 Top-Wetten Gambling Germany
163 Ubet2Win Gambling United Kingdom
164 Unibra Alcohol Belgium
165 Valereum Blockchain Gambling United Kingdom
166 Vranken-Pommery Monopole Alcohol France
167 Wap Integrators Gambling United Kingdom
168 Webis Holdings Gambling United Kingdom
169 William Hill Gambling United Kingdom
170 World Gaming Gambling United Kingdom
171 Wuerzburger Hofbraeu Alcohol Germany
172 Zeal Network N Gambling Germany