Views Article – Sharenet Wealth


Is Ethical Investing Best, Or Is It Better To Be Bad?

When it comes to share selection, is it important to you that the companies you invest in behave ethically, and care about society and the environment? Or do you adopt a live-and-let-live approach and invest where you believe you will get the highest returns? 

Recent trends suggest that investors are increasingly behaving in a ’responsible’ manner, and that the live-and-let-live attitude is losing ground. In a recent study, London Business School academics Elroy Dimson, Paul Marsh and Mike Staunton note that the world’s largest asset owners now devote extensive resources to social and environmental issues and corporate governance, and to engaging with investee companies on these issues. 

This is evidenced by the fact that, as of 2014, fund managers controlling about 50% of the global institutional investor market had signed up to the UN-supported ’Principles for Responsible Investment.’ Furthermore, The Global Sustainable Investment Alliance estimates that, worldwide, some USD 14 trillion of professionally managed portfolios incorporate environmental, social and governance concerns into their decisions.

Why this sudden urge to be good? Are returns improved by responsible investing, or does it in fact pay to be bad? These are the issues that Dimson et al set out to investigate, coming up with some interesting and perhaps surprising findings. Let’s start by looking at why it might pay to be a good guy.

The benefits of virtue

According to Dimson et al, there are three reasons for choosing to be a responsible investor. First, the owners of businesses share responsibility for the firms’ actions. Second, owners can induce firms to improve corporate behaviour. And third, long-run returns may be enhanced by ensuring that companies have high standards of behaviour.

While the first two reasons might make investors feel better about themselves, the suspicion is that better returns are the most powerful motive for responsible investing. In this regard, Dimson et al cite the example of the Vanguard FTSE Social Index Fund, which tracks an index screened on the basis of social, human rights, and environmental criteria.

Companies making up the fund have superior environmental policies, strong hiring/promotion records for minorities and women, and a safe workplace. What is more, there are no companies involved in tobacco, alcohol, adult entertainment, firearms, gambling, nuclear power, and unfair labour practices. The fund has assets under management of USD 1.5 billion, and many investors in this ethical fund emphasize “doing well by doing good.” They consider that investing in responsible and principled companies is likely to be rewarded in the long run by better stock market performance.

Dimson et al also cite the works of two authors who support responsible investing. The first, Peter Camejo, wrote the book: “The SRI Advantage: Why Socially Responsible Investing Has Outperformed Financially.” Camejo notes that he “presents overwhelming evidence that SRI has outperformed financially, explains in detail why SRI outperforms, and then examines the implications for investment professionals, investors, pension funds, and community/non-profit groups.” Camejo is backed up by second author John Harrington, in his book: “Investing with Your Conscience: How to Achieve High Returns Using Socially Responsible Investing.”

The wages of sin

If you suspect that the above-mentioned claims might be somewhat overstated, you’d be right. Dimson et al admit that “In reality, however, much of the evidence that we reviewed suggests that… ’sin’ pays. Investments in unethical stocks, industries and countries have tended to outperform.”

To illustrate this, they compare the performance of The Vanguard FTSE Social Index Fund (mentioned above) with that of The Vice Fund, which invests in businesses that are considered by many to be socially irresponsible. Recently renamed the Barrier Fund, it has assets of $290 million invested in “industries with significant barriers to entry, including tobacco, alcoholic beverage, gaming and defence/aerospace industries.” Both funds were launched in the early 2000’s.

Investors putting $10 000 into each of these funds at inception, and who reinvested all dividends earned, obtained rather different results by early 2015. The socially responsible investors saw their $10 000 grow to $26 788, not a bad result, but those who had chosen the Vice Fund were better off by some $7 000, their initial investment having snowballed to $33 655. Sadly for the responsible investors, if they had opted for a fund tracking the S&P 500 index they would have had better results, earning a return about mid-way between their Social Index fund and the Vice fund.

Why sin pays

The above-mentioned example illustrates that principled investors will generally pay a price for their convictions, by way of lower returns.  Ironically, responsible investors also need to recognize that they may be partly responsible for the higher returns from sin.

Dimson et al note that the standard argument suggests that irresponsible businesses can be disciplined by the threat of divestment of the firm’s shares. The assumption here is that selling off their shares will put downward pressure on the share price. This will make the company less valuable, pushing up its cost of capital by affecting its ability to raise finance. It might also raise the likelihood of a takeover bid. More significantly, lower share prices are likely to hit executives where it hurts; through lower incentive payments and less valuable share options.

However, as Dimson et al also point out, it can be profitable to invest in stocks that ethical investors avoid. The rationale for “vice investing” is that these companies have a steady demand for their goods and services, regardless of economic conditions. They also operate globally (“vice” is a worldwide phenomenon), tend to be high-margin businesses, and are in industries with high entry barriers.

Vice companies can also represent good value, exactly because of the standard argument mentioned above. If a large enough proportion of investors avoid “vice” businesses, their share prices will in fact be depressed. However, if companies have a lower share price, they offer a buying opportunity to investors who are not too bothered by ethical considerations. Dimson et al cite Caroline Waxler, who supports this view in her book: “Stocking Up on Sin: How to Crush the Market with Vice-Based Investing.”

The paradox, then, is that depressed share prices for what some regard as nasty and irresponsible businesses may result from the well-intentioned actions of responsible and ethical investors. Lower prices in this case don’t suggest poor fundamentals, so that ’vice’ shares may trade at a lower price/earnings or lower price/dividend ratio, and buying them would offer a superior financial return. For some investors, this will be enough to quiet the small voice of their conscience.

Smoking is good for your returns

Dimson et al cite a number of research studies that support the outperformance of ’sin’ stocks. It appears that institutional investors tend to avoid sin stocks, which typically sell at a lower price in relation to fundamentals. This produces larger expected returns for these shares, with tobacco companies being particularly relevant in this regard. 

A study by Hong and Kacperczyk produce fascinating results. During the early years of the 20th century, tobacco was not seen as being harmful. However, this view changed during the years 1947 to 1965 as tobacco slowly moved into the ’sinful’ category. During this period tobacco shares underperformed the market by an average of 3% per year.

After 1965, when the health effects of smoking cigarettes became well-known, sentiment changed and tobacco companies faced a barrage of litigation. Despite this, between 1965 and 2006 these same companies outperformed comparable firms by more than 3% per year.

From their own research, Dimson et al estimate the outperformance of tobacco stocks over a complete 115-year period. It emerges that tobacco companies beat the overall equity market by an annualized 4.5% in the US and by 2.6% in the UK (over the slightly shorter 85-year period of 1920 – 2014).  

Although tobacco has the longest history of outperformance, other sinful categories have done very well in recent times. A study by Fabozzi, Ma, and Oliphant revealed that, between 1970 and 2007, across various countries, the average excess returns from the various sin categories were 5,3% (alcohol), 9,6% (biotech), 10,0% (adult services), 14,7% (tobacco), 24,6% (weapons), and 26,4% from the ultimate winner, gaming (betting).


Staying good or breaking bad is a decision for the individual investor. Whether you choose responsible and ethical investments, or pursue maximum returns irrespective of the products and services being peddled, is entirely up to you. However, it may be worth considering that the societal improvements we have seen over the past hundred years (such as the vote for women, the abolition of slavery, the anti-racism movement, and so on and on), have often come about because ordinary people acted bravely and did the right thing. Perhaps, in the great scheme of things, choosing a better world is more desirable than chasing higher returns.


“Responsible Investing: Does it Pay to be Bad?” By Elroy Dimson, Paul Marsh and Mike Staunton, published in the Credit Suisse Global Investment Returns Yearbook, 2015.



AJ Cillers

AJ is an academic and a freelance financial journalist who has written for Sharenet for some 15 years. He spent 25 years as an accountant and financial manager in various South African companies before moving into academia. He has a broad range of interests, including all aspects of business and stock market investing. Apart from a bachelor’s degree in Accounting, AJ holds a Master’s degree in Financial Management. He is also a Fellow of the Chartered Institute of Management Accountants.

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