Not too long ago ethical investing was all the rage but new vice funds hopeto appeal to investors' baser instincts by including tobacco, defence, alcohol and gambling stocks in portfolios, write Julie Earle and Florian Gimbel.
Vice versus virtue - it's a battle that has been waged across the equity markets over the years. And until recently, it looked as though virtue had gained the upper hand.
In the bull years, the ethical movement - redefined as socially responsible investment - grew dramatically.
But now, fund managers appealing to man's baser instincts are finding a market for their investment approach.
This month, Mr Dan Ahrens introduced the vice fund. It invests in companies eschewed by the SRI brigade: tobacco, alcohol, defence and gambling.
It joins Burton Morgan's Sin Shares, which was initiated 15 years ago and invested in tobacco. Its name was changed some time later to Morgan FunShares, after Sir John Templeton - the famous investor, friend of Mr Morgan and a committed Christian - objected to the word "sin".
The arrival of the vice fund is sparking a debate on the merits of morality as the incentive for investment.
Mr Ahrens insists his fund is a good financial investment. "The important thing is this: many investors nationwide can relate to this fund. It's not about what is right and wrong, but about the numbers." He points out that Philip Morris, one of the fund's top holdings, has outperformed GE, Disney, Merck and other blue-chip stocks over the past 30 years.
But some critics have been quick to dismiss the fund as a gimmick designed to prompt disenchanted stock market investors to turn their attention to mature, cash-generative companies.
Ms Amy Domini, founder and chief executive of Domini Social Investments, a New York investment specialist, blames interest in vice funds on corporate disasters such as Enron and WorldCom. This, she says, has made investors "desperate".
"There may be a sense among investors now that investing is a rigged game, that you can't win," she says. "People will always drink and smoke, and maybe they are going with that - rather than taking a look at the long-term investment approach."
Others have suggested the funds are trying to tap into a rebellious segment of society.
Mr Meir Statman, professor of finance at the Leavey School of Business, Santa Clara University in California, says people may be flocking to vice funds because they are sick of "goody-goodies".
"People who want to single out tobacco and alcohol companies may do it to express exasperation with those who want to reduce the amount of smoking," he says.
He says a vice fund may appeal to these people's contrarian viewpoint. "Vice funds seem to be a gag. It's a fun idea and has novelty value."
Yet others claim that vice funds are little more than value funds with an eye-catching name.
"People might think this is a very sexy investment," says a rival from a UK-based SRI fund, "but it really is a boring fund full of defensive stocks that only perform well in down markets".
Mr Ahrens is happy to bat this criticism aside.
He concedes that "boring", cash-rich companies are precisely what investors want at the moment - but insists that his fund is here to stay.
"We believe the reason we do well is in spite of the market, not because of it," he says.
"When the market goes up, people will (continue to) drink and gamble."
Mr Ahrens has already seen €1 million flow into his new fund - and he expects bigger inflows through companies such as Fidelity and Charles Schwab, the online brokerage.
It comes as SRI funds struggle in the bear market. By midday last Friday, the Dow Jones Sustainability index had dropped to 633.84 - down from its peak of 1292 in March 2000.
According to Morningstar, which tracks 152 SRI funds in the US, the average fund has lost 22.5 per cent in the year to date.
The Domini Social Equity fund, which has $1.6 billion (€1.62 billion) of assets, has returned an annual average of 9.71 per cent since its inception in 1991. This compares with the S&P 500 index, which has returned 10.1 per cent on average over the same period.
In the year to August 31st, the fund showed little resilience in falling markets.
It was down 18.03 per cent, nearly as bad as the 19.4 per cent drop in the S&P 500 index.
Yet, for all this, SRI funds - notably those run by ISIS, Henderson Global Investors and Jupiter - are still reporting fresh inflows of money.
In his new book, Morals, Market and Money, Alan Lewis, professor of economic psychology at the University of Bath, quoted a 2000 survey of 1,000 ethical investors, which found that 80 per cent of the respondents would stick with their funds.
This suggests that SRI investors are not just looking for investment returns.
"People care more about what they buy and how they live," says Prof Lewis. "They are moving away from pure wealth-maximisation."
Vice fund investors, meanwhile, do appear to be putting returns first and the rest of the world second.
"I believe everyone is looking for a way to make money from an investment standpoint," says Ms Shalmir Tipit, a 40-year-old marketing director of a Dallas-based architecture firm, and a Vice Fund investor. "The numbers have performed well."
If the image of a vice investor is a corpulent, cigar-smoking gambler who likes to drink, then Ms Tipit dispels this at once.
"I do drink," she confesses, "but I don't smoke and I don't know how to gamble. But I guess investing in stocks is just that." - (Financial Times Service)
