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Cutting cigarettes out of your life is certainly good for your health, but what about the value of your investment portfolio?

For some who want to align their investments with their social values, that question is of little concern — they are happy to wash their hands of industries such as tobacco or guns, even if there is a chance it could cost them a few basis points in the annual return on their assets.

On the other hand, those who value returns above all else may see an opportunity to outperform by scooping up holdings that have been shunned by others. There is a handful of exchange traded funds they can use to invest in these so-called sin stocks — but the wages of sin are still a matter of debate.

The only broad-based sin stock ETF on the market is the AdvisorShares Vice ETF, according to Morningstar data. The fund invests solely in US-listed companies that generate at least 50 per cent of their revenue from alcohol, cannabis or tobacco, according to ETF.com.

The vehicle, whose ticker code is ACT, was launched in December 2017 on the idea that “investing in select alcohol and tobacco companies will provide continued growth and long-term performance across all types of market environments”.

That thesis has yet to come to fruition, however. Since inception, ACT is up 1.5 per cent while the S&P 500 has risen nearly 9 per cent. To date, the fund has attracted $14m in assets.

Other so-called “vice ETFs” have not fared much better. The largest fund on the market is ETFMG’s $1.2bn Alternative Harvest ETF (ticker code MJ), which invests in cannabis companies. It has done better than the AdvisorShares fund, returning about 13 per cent annually since it launched in 2015. MJ rose roughly in line with the S&P 500 — albeit in a far more volatile fashion — following its inception in December 2015. But since April this year the fund has dropped by 17 per cent while the benchmark index has continued to rise.

The sin stock ETF market is still in its infancy, though there is evidence to show that embracing contentious investments can pay off.

A battle is brewing at Calpers, the $375bn California state employees’ pension fund, over this topic. Since divesting from tobacco stocks in 2001, Calpers has lost out on approximately $3.6bn and one of its board members is pushing the fund to reconsider its decision.

“One per cent of the fund is a lot of dinero,” said Jason Perez, a police sergeant serving his first term on the Calpers Board of Administration. Mr Perez called for the fund to examine the issue at a board meeting earlier this year, arguing that the pension should not be limiting itself from any possible source of returns.

In 2017, David Blitz, head of quantitative equity research at Robeco Asset Management, and Frank Fabozzi, a professor of finance at EDHEC Business School, examined why sin stocks tend to outperform the market. They found that these assets do not necessarily outperform for the reasons people think they do. 

“A popular explanation for the observed abnormal returns of sin stocks is that they are systematically underpriced because so many investors shun them,” Mr Blitz and Mr Fabozzi wrote. However, this explanation did not stand up to scrutiny. The researchers found that sin stocks’ ability to beat the market “[disappeared] completely” when they accounted for other drivers of return such as size, value, and momentum.

Sin stocks are just one group of assets in investors’ crosshairs for divestment. In many cases, investors are ridding themselves of fossil fuel investments to send a message to the markets about climate change. “We believe that ending institutional investment in companies that extract fossil fuels and contribute directly to climate change can help send a very powerful message that renewables and low-carbon options are the future,” New York City mayor Bill DeBlasio and London mayor Sadiq Khan wrote in a letter to The Guardian announcing their divestment plans last September.

ETF investors who want to take the other side of this bet have plenty of options available to them. Morningstar’s database lists 26 energy-focused ETFs. The largest fund of the group is the $12bn Energy Select SPDR from State Street Global Advisors.

However, the reasons for fossil fuel divestment are not always purely symbolic. Many investors are worried about future policies that could force companies to keep oil and gas reserves in the ground. These “stranded assets” could significantly dent their future returns.

Coal companies, in particular, have been hit hard by these expectations. Calpers cut thermal coal in 2017 in a divestment that, it argued, had avoided making a $108m loss had it continued to hold these stocks.

In March, BNP Paribas Asset Management also announced its plan to shed up to €1bn of coal stocks, saying the fossil fuel is set to become “increasingly uncompetitive as a fuel for power generation”.

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