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Economics & Finance - BLOG

Doing Good by Investing in Sin

Theo Vermaelen, INSEAD Professor of Finance  |

Diverting investments away from “sin” doesn’t necessarily make the world a better place.

The recent growth in ethically and socially responsible funds now represents trillions of dollars of mandates.  Many of these funds engage in negative screening – excluding investments that are involved in activities that are considered unethical or socially irresponsible such as defence, guns, alcohol, tobacco, adult entertainment, gambling, nuclear energy and, most recently, fossil fuels. The argument of the sellers of these funds is that investing ethically with them will make the world a better place.

Many of these funds tell their investors that it will be a “win-win” situation: you are “doing good” and you also create “alpha”, i.e. you beat the market. Their argument is that the market undervalues the long-term negative consequences of being involved in socially irresponsible activities. Fund managers are now, for example, asked to incorporate climate change risk in their investment process.

Some large investors push the corporate social responsibility (CSR) agenda even further by becoming impact investors (different from activists, who focus on shareholder value). For example, the Dutch pension fund, ABP, one of the largest pension funds in the world, sent me a letter (I am a beneficiary) proudly announcing that thanks to its efforts Shell had given up searching for oil in the Arctic seas:

“Because of the fight against global warming the demand for oil will go down. In these circumstances is it responsible to invest in a vulnerable area such as the North Pole? Are there no better alternatives? Why not invest in Brazil instead?”

So the pension fund manager believes that he is smarter than the Shell executive who is apparently investing in negative NPV (net present value) projects, without realising it. Shell’s decision to abandon the Arctic drilling project was announced on September 28th, 2015. On that day its stock price fell by 3 percent, roughly in line with the oil stock index and the S&P 500. If markets believed that this was a negative NPV investment, its stock should have risen, or at least fall less than the S&P 500. So the market disagreed with the ABP pension fund manager. 

The tenuous impact

The idea that avoiding “unethical” stocks makes the world a better place is even more questionable. If, for example, you sell shares of Smith & Wesson, the gun manufacturer, because you believe that manufacturing guns is unethical, someone else (who does not agree with your values) will buy them. Nothing happens to Smith & Wesson. The number of guns sold in America is not affected.  So the claim that you make the world a better place when you invest in funds that exclude sin stocks is obviously false. Fund managers seem to exploit naive investors who don’t seem to understand that buying a stock is not the same as giving money to the company. Only in the case of IPOs or secondary offerings you affect the company’s cash flows. Moreover, serious academic research  by LBS professors Elroy Dimson, Paul Marsh and Mike Staunton shows that sin stocks beat the market, which is the opposite of the claim that “doing good” generates higher alpha. This is not surprising as they are good theoretical reasons for this: if an asset is not wanted because investors feel bad about owning it, its expected return has to be higher to compensate for this bad feeling. However, this also means that investors who don’t care about ethics will earn a higher expected return. Socially responsible investment funds, if they become important enough to have an impact on asset prices, will be a prime example of “good intentions with bad results”. 

Ironically, this is admitted by the CSR advocates who claim that socially responsible companies increase shareholder value because they lower the cost of capital. But if the cost of capital is lower, the expected return on equity will be lower as well. The argument that these stocks nevertheless are good investments is based on a convoluted hypothesis that the market underestimates the reduction in the cost of capital and/or the increase in the cash flows, but over time, the market will incorporate the wisdom of the CSR fund manager. 

The case for sin reporting

Rather than misleading investors by making them believe that investing in a fund makes the world a better place, I would like to propose a new approach that actually achieves this social objective without sacrificing alpha.

First, the portfolio manager is given absolute freedom to pick stocks according to the best of his or ability, with no restrictions on the universe of stocks he or she can invest in. In other words, the manager is free to maximise alpha.

Second, each quarter the fund would report separately the total profits, and profits per share made on the stocks that would qualify as “sinful” or stocks with low social responsibility scores.  This will allow each investor to calculate to what extent he or she has benefited from “sinful” activity.

Third, the fund will keep a “sin balance sheet” where all cumulative net profits from sinful investment are recorded. This may, of course, include subsequent losses. Although sin stocks are expected to beat the market on average, in the long run, this is not necessarily true each year.

Fourth, investors can then reconcile their social and investment goals by donating the profits from “sin” to a good cause that directly makes the world a better place. They could do this by asking the portfolio manager to sell some sin stocks in the portfolio but they could also use other funds, of course.

For example, consider an investor who invests US$100,000 in a fund that has 5 percent of its assets in Smith & Wesson in January 2012, so the investor has invested US$5,000 indirectly in Smith & Wesson. Since January 2012, S&W’s stock price has increased by 433 percent from US$4.50 to US$24, largely as a result of terrorist attacks and gun owners’ fears that US President Barack Obama would take away their guns. The socially responsible investor could then use his profits (US$21,650) to donate to a group that lobbies against the National Rifle Association.  

I understand that it will take time for my proposal to be adopted as it requires rational, rather than emotional thinking about investments. The success of the socially responsible investment industry shows that marketing based on exploiting emotions and irrationality – unfortunately – works. 

Theo Vermaelen is a Professor of Finance at INSEAD and the UBS Chair in Investment Banking, endowed in memoriam Henry Grunfeld.

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So by investing in "Sin" and donating the returns from investing in "sin" to a lobby which will get legislation changed to make "sin" illegal and therefore making my entire "sin" investment worthless is a better approach than not investing in "sin" at all?
Would think not investing in "sin" and donating a small piece of you investment return to that same lobby (maybe the returns of investments you chose instead of the "sin" investment) gets you a better overall result?

Theo Vermaelen,

Of course, this is not the only way to make the world a better place : give money directly to good causes like setting up a social enterprise for example, but then we are talking about start-ups and private companies. My critique is on funds that invest in listed companies and make their investors believe they improve the world.

Fallen Star Rising,

At the point when your lobbying starts to make a difference, your fund manager sells the shares in the "sinful" company before it has a significant impact on your portfolio. We want the sin to stop and so for as long as it's making a profit, we'll take some of those profits to help ensure that it does stop.


After his controversial article about climate science, Prof Vermaelen again tries to set up a provocative theory and fails to establish concise logical arguments to back it up. Specifically, he confuses two ways to react to unacceptable corporate behavior.

The research by LBS Professors Elroy Dimson, Paul Marsh and Mike Staunton, that Professor Vermaelen uses to back his point that responsible investments yield in lower returns than sin investments, concludes that investors can chose between exit (divestment) and voice (Impact Investment), two concepts that Professor Vermaelen fails to distinguish between.

In his argument, he begins with a claim he attributes to managers socially responsible funds: “Many of these funds tell their investors that it will be a ‘win-win’ situation: you are “doing good” and you also create ‘alpha’, i.e. you beat the market.” He then continues to describe how the ABP fund managers informed him that “thanks to its efforts Shell had given up searching for oil in the Arctic seas”, which is a classic example of impact investment. He tries to create the impression that becoming an impact investor is the escalation or extreme form of the strategy that starts with divestment from sin stocks. Quite the opposite.

Prof Vermaelen concludes from the letter he received from the ABP fund managers, that they believe they are smarter than the Shell executives. He demonstrates that the market disagrees with the ABP managers and the decision by Shell was not particularly welcomed by other investors.

However, that was not the premise under which he began his critique. The Global Impact Investing Network defines impact investments as investments made into companies, organizations, and funds with the intention to generate social and environmental impact alongside a financial return. And this is exactly what the ABP managers did. They used the influence that their investment gave them to avoid an environmental impact they thought is irresponsible.

The argument about the ABP fund strategy is therefore a classic straw-man. The author started with a premise, twisted it around and then rebutted the distorted version in the hope the reader does not notice his twist.

Interestingly, the very research that Professor Vermaelen quotes, concludes that while divestment might indeed lead to lower returns, impact investment has shown to be profitable in a number of cases. Although the authors concede that the research on this is not exhaustive, they refer to a recent study that concluded that there is a significant increase in abnormal returns in companies in the 12 months after the successful engagement of environmental/social or corporate governance engagement by impact investors.

The fund managers of Professor Vermaelen’s pension fund might therefore have done him a favor. Not only have they contributed to the decision to avoid an unpredictable risk to an extremely vulnerable and pristine environment. The massive out-performance of Shell against the S&P Global Oil Index since the decision (+42.4% vs +11.6% as of June 30th), might have proven him wrong by giving his pension an unexpected boost.

Theo Vermaelen,

Dear Henning

Good to hear from you ! Better a follower who does not like me than to have no follower at all. As your comment focuses on ABP and Shell let me explain.

The ABP pension fund manager suddenly has decided, without asking beneficiaries such as myself, to become an impact investor. I don't like impact investors for a variety of reasons. First they openly state that their goal is not financial returns but social and environmental impact. They have found a convenient excuse for charging management fees without providing alpha on earth ( verifiable) in return for alpha in heaven (unverifiable). As the FT pointed out recently ( July 18 : "Actively failing") most actively managed funds don't create alpha on earth and the CSR asset management industry has found a clever way around this. Second, any reasonable analytical person realizes that the impact of Shell on global warming is not statistically significant. Three, the idea of pushing oil and gas companies into alternative energy (the main "strategy" of the impact investors) has been a bad financial idea : the S&P Global Clean Energy index has lost 10 % per year since 2006. At the time when pension funds are under distress ( decline in interest rates has increased the present value of pension liabilities ) encouraging companies to destroy shareholder value is socially irresponsible.

By the way crediting the decision to stop exploration in the Arctic for subsequent good long term performance of Shell makes little sense. To assess the impact of a decision on stock prices you have to measure the impact at the time of the decision. Other presumably good information about Shell has appeared subsequently.

Now what should ABP do to appeal to the irrational investor public who believe they can save the world from climate change? Well follow the proposal of the Dutch government ( made in February this year) of breaking up ABP in 14 different pension funds. Pensioners are then free to choose the policy that fits best with their objectives and "values".


Dear Prof Vermaelen,

I enjoyed reading your response and I will gladly add some important points:

You are of course entitled to your own opinion and therefore I will not try to argue with your first reason that you use to justify your disapproval of activist investors. It is your right to prioritize money over sustainability and I accept that. However, I would like to point out several misunderstandings (or strawmen?) in your following two reasons that distort your argumentation away from the actual issues:

1.) As a matter of fact, Shell’s impact on global warming - or climate change as the scientific community calls it - is indeed significant (Heede, R. Climatic Change (2014) 122: 229. doi:10.1007/s10584-013-0986-y): Shell has emitted 2.12% of all global GHG emissions until 2010). It is the sixth largest emitter of greenhouse gases after Chevron, ExxonMobil, Saudi Aramco, BP and Gazprom. In its history, Shell has emitted CO2 and CH4, roughly equivalent to one annual global emission. Even if you consider this statistically insignificant, which I doubt, it doesn’t matter, because

2.) The main reason for the public critique of Shell’s arctic exploration activities was not its impact on climate change. It was the fear for one of the last untouched and pristine ecosystems on this planet. The two concerns have a similar origin, but are two completely different issues.

3.) Please correct me if I am wrong, but the intention of ABP did not seem to be to push Shell into investing into alternative energies. From the snippet you provided, I conclude that they did not agree with the decision to drill in the arctic sea, as opposed to other oil-related investments, e.g. in Brazil, where oil might be cheaper to extract, less risky for the environment and have less potential of creating stranded assets.

Before they cancelled their activities, Shell itself has argued that Arctic oil could be financially viable at prices of $70, under the condition that sufficient quantities could be found. (US puts a plug on Arctic oil exploration, Financial Times, Oct 17, 2015). Oil prices were far below $70 already and the decision to quit the arctic was finally made after the first exploration drills yielded sobering results. Considering the oil prices at that time and today, the decision was not the economic suicide as which you try to paint it.

As you write in your initial article, Shell’s stock price did not move significantly in relation to the oil stock index and the S&P500. The Market had already considered the NPV of that project to be $0. In fact, you could even argue that ABP managers were simply concerned about their financial investment. As Marc Carney, governor of the Bank of England, has publicly warned investors of stranded assets in the fossil fuel industry just one day later, that might have been a valid concern. It is the right of every investor to assess the risk to an investment independently and to take action if she thinks the market undervalues them. The strong commitment to the Paris Agreement less than three months later, in which more than 190 nations agreed to reduce the emission of carbon dioxide and the use of fossil fuels faster than ever before, only confirmed this concern.

However, let’s neglect all the risks for a moment. The pristine environment, the biodiversity at risk and the massive PR damage, the risk of stranded assets, the risk of losing credibility and influence in the process of shaping international climate change policies, all of which were probably already part of the stock price. Instead of continuing a NPV-neutral project that binds large amounts of capital, wouldn’t it in deed make sense to invest the money in a project with a positive NPV, for example in Brazil? Maybe, just maybe, the “other presumably good information about Shell” that has appeared subsequently, is the result of NPV-positive projects realized with the freed capital.


This paper just ignores basic psychology research.

Theo Vermaelen,

Obviously I don't. People are irrational and that's why the socially responsible investment industry is very successful in exploiting this irrationality.


"Irrational action" is a non-sense. The ultimate end of action is always the satisfaction of some desires of the acting man. In our case, you are wrong thinking that most SRI investors want to "do good" or "make an impact". It is just a fraction of them (see GSIA survey 2014). For most of them, the acting man is just looking for rational and basic cognitive consistency. Take AXA and tobacco divestment, there is no intention to "do good", of course the stock will be bought by someone else, but there is an intention to deliver cognitive consistency.
You can call it irrational but this is a rational decision. That being said, I agree divestment strategies are useless if the intention is to "do good" but my concern is that the solution you suggest doesn't address the "acting man" desire for consistency.


What about the scenario where an investor simply decides not to try to make money from "sinful" companies, instead focusing on those companies that are engaged in more ethical activities. There is an underlying assumption in this article that the investor is always trying to achieve the highest return. It may be the case that the investor is trying to achieve the most ethical return and is not interested in either supporting or punishing "sinful" companies.

Theo Vermaelen,

No all I am saying is that the investor who believes she is punishing sinful companies by not investing them is wrong. When you sell a stock there is a buyer. You have not changed anything except the ownership. The owner is now someone who does not care about ethics. The basic thing you should remember from your basic finance course is : if you exclude an asset from a portfolio for any other reason than overvaluation you are worse off. You have to make the case the unethical company is overvalued which means that it should underperform. But the empirical evidence simply shows the opposite.


So "sin" stocks trade at a discount for whatever nonsensical reason.

An investor invests in sin stocks.

Those stocks go up / down based on catalysts and macro but still trade at a discount relative to what they would if they were "un-sinful" because those same institutions are avoiding them based on mandate.

So .. what's the point?

Buy, Hold Long,

This is an interesting post. I don't think I agree with most points that are raised but it is interesting non the less.

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