This post will at first appear like a discussion about morality, but I hope it will end as a post about objective reasons for market cap weighted equity indexing. So hang tight even if your head starts to explode a little.
Here’s a good piece by Felix Salmon on why we should avoid “sin stocks”. In it, he disagrees with a piece by Cliff Asness and Matt Levine. The basic gist of the disagreement is that Matt and Cliff say that avoiding sin stocks could make it more expensive to finance their future operations which will lead to fewer sinful companies and Felix says that not investing in these companies is unlikely to have a meaningful real world impact.¹ I think they’re having the wrong discussion though.
This is going to annoy many of you, but a lot of this strikes me as virtue signalling. Matt, Cliff and Felix are having this discussion assuming that they know what is and what isn’t virtuous. I would argue none of us really knows a virtuous company from one that isn’t. Yes, you might have a general idea of what is virtuous, but there is no specific way to determine this other than a company that operates illegally and one that operates legally. Aside from that, the idea of a “sin stock” is rather murky. Obviously, since all publicly traded companies are operating legally then the idea of a “sinful” company must be rather opaque.
I know, I know, alcohol, tobacco, firearm and casino companies are obviously bad. They operate distasteful businesses, but they also provide goods and services to many people who find them very valuable. While most of us might find some of these businesses distasteful or even immoral they have a clientele that finds them valuable. And if a company operates legally then who is to say whether a cheeseburger (which is one of the most lethal things Americans consume) is more sinful than an AR-15? There might be degrees of sin in the way these companies produce their goods and services, but there is no clear line for the sinners vs the non-sinners.
So while you might think a stock is sinful there might be a small sinful group of people who think that company provides a wonderfully sinful service that they are willing to pay gobs of money for. To these people that company is not sinful at all so who are we to declare that certain companies are sinful while others are not? That strikes me as a dangerous generality. Capitalist entities are inherently selfish to some degree. They want to lure you in and get you addicted to their products and maximize as much profit as possible while hopefully selling you something you find so valuable that you’ll stay addicted to it. Said differently, all capitalist entities sin a little. They didn’t become huge public companies by being charities after all. And do we really think we can determine that gray area between the companies that sin a lot and sin a little? Call me skeptical!
So I think Matt, Cliff and Felix are having the wrong debate. They assume we can actually determine the sinners from the non-sinners in the first place. But I say that’s not borne out in the evidence. Matt cites a recent study showing that sin stocks do beat the market. But there’s a study somewhere showing that every investment strategy ever created is a good one. But what about where the rubber meats the road? Luckily, there’s an actual VICE mutual fund with a long track record and that track record is somewhat mixed. While the fund has outperformed over the course of 15 years it has lagged the Vanguard Total Stock Market Index over the last 1, 3 5 and 10 year periods.
This evidence makes it hard to argue that investors can actually determine what is and what isn’t a “sin stock”. After all, if a fund manager who specializes in finding sin stocks can’t consistently find them then why would the average individual investor have better luck doing this?
The key point I am driving at is that much of this strikes me as virtue signalling and a rationalization for active stock picking. We don’t really know what a good value stock is any more than we know what a good sin stock is. I know, you think you know, but the evidence on active stock picking bears this out year after year. But Wall Street will continue to sell you the idea that they know which stocks you should or should not own. Some will justify that with fundamental evidence about how they pick stocks based on fundamental metrics while others might sell you something that sounds morally pleasing. But none of them really know which stocks will behave sinfully or not. So why would we engage in the process of trying to make a profit from perfectly legal entities knowing that they all sin a little while trying to pick which ones sin less than others? In other words, if we know stock pickers are bad at picking stocks then why would we complicate matters by bringing our own emotions into an already difficult process?
My own view is simpler. While I have absolutely no problem with someone who doesn’t want to profit off the backs of companies they don’t agree with, I think they are very likely to find that they are doing themselves a disservice by earning a lower return trying to pick which stocks are “good” and which ones are “bad”. And in doing so these virtuous people will actually end up owning a smaller portion of the aggregate wealth pool thereby leaving them with fewer funds to be virtuous with. I say if you want to be virtuous then make as much money as possible and do good things with those funds. Since we know stock pickers tend to earn a lower average return than market cap weighted indexers the very best thing a virtuous asset allocator can do is own the good AND the bad and do good with the profits all of these companies send your way. That way you are maximizing your own ability to be virtuous and have a positive impact on the economy as opposed to potentially leaving those funds in the hands of people who might not have the same virtues you do.
NB – I am not making an excuse for companies that do distasteful things. I don’t support many of the types of companies mentioned above (except for the cheeseburger companies – you guys are great and I hope you never go away). Again, this is not a moral story in any way. It is a purely objective view that tests the idea of whether we can even identify what it means to be a sinful company.
¹ – Regarding this specific debate I also think they’re having the wrong debate. If you really want to hurt a public company (which already has access to liquid markets by simply being on a public exchange) then the place to hurt them is in the real economy. If you really want to hurt a public company then protest their service in the real economy by refusing to buy their goods and services. Hitting them in the secondary market where they probably don’t finance their operations in the first place is an incredibly inefficient way to protest a company you detest.