The Virtues of Vice
Would you rather get rich or feel holy? That's how Charles Norton frames the dilemma of choosing between investing in the four sinful industries in his Vice fund (symbol VICEX), or putting your money in "socially responsible" businesses. Norton, portfolio manager of Vice, doesn't think you can have it both ways.Socially screened stock funds -- also known as "socially responsible" funds -- have lagged the Standard Poor's 500-stock index, while shares of tobacco, alcohol, gaming and defense companies have topped the index over the past few years. For instance, the Domini Social Equity fund returned 11% annualized over the past three years, trailing the SP index by three percentage points a year. Over the same period, Vice fund gained an annualized 27%.
And that's during a strong bull market. Shares of companies in vice industries tend to make dandy defensive stocks during economic downturns. Why? "They're almost immune to what's going on in the economy," says Dallas-based Norton. "People will always smoke, drink, gamble and fight." Human frailties are global phenomena. Nearly a quarter of Vice's portfolio is devoted to foreign stocks such as British American Tobacco and Kirin Brewery of Japan.
Indeed, the gap between the performance of socially screened funds and vice investments is such that, in Norton's eyes, there's a professional dilemma for the moral fund manager. "There's a conflict between social and fiduciary responsibility," he argues. "A fund manager has a fiduciary responsibility to the beneficiary to achieve the highest return for a fixed level of risk." This he or she can't do by shunning the lucrative sin stocks and sticking to weaker-performing "socially responsible" companies. If you want to do good, Norton has a suggestion for you: Take your investment profits and donate to charities -- but don't make investment decisions based on beliefs.
Let's take a look at the four vice sectors and Norton's top picks in each.
Smoking is declining in the U.S., but it's on the rise overseas, which is why Norton is keen on Altria (MO), formerly Philip Morris. Altria recently secured approval to start making and selling Marlboro cigarettes in China, home to 350 million smokers, a figure greater than the entire U.S. population. Cash-rich Altria last year acquired large tobacco companies in populous Indonesia and Colombia. Norton predicts that Altria will be broken into three companies -- domestic tobacco, Philip Morris International, and Kraft Foods. Using a sum-of-parts evaluation, he thinks Altria stock, recently $71, is worth $100 a share.
Booze is a steady business, year in year out, a beverage ingrained in societies across the globe. Norton likes Diageo for its global reach and leading position in spirits, a growing business in demographically aging societies. Diageo, which peddles brands such as Smirnoff and JB, is a leading supplier to Wal-Mart, which plans to quintuple alcohol sales, says Norton. He likes Diageo for its aggressive stock-repurchase program and high dividend. Diageo, which trades in the U.S. as an American depositary receipt under the symbol DEO, recently fetched $68, or 17 times estimated 2006 profits.
Norton views tobacco and alcohol as value-oriented stocks; gaming and defense have growth characteristics. The big growth market in gambling is Macau, the tiny former Portuguese colony on China's doorstep. The Chinese have a terrible weakness for gambling, and they flock to Macau in droves. That's why Norton adores Las Vegas Sands (LVS). The Sands Macau casino, just over a year old, hit the jackpot; LVS will open a Venetian casino in Macau in 2007 and plans to develop six more properties in the enclave. At $68 a share, LVS sells for a heady 53 times 2006 earnings, but analysts think profits will grow 44% next year and 20% compounded over the next five years.
The fight against terrorism led Norton to American Science and Engineering (ASEI), a small company that makes high-end X-ray systems used in airports, ports and border monitoring. He sees a great growth opportunity in container ports -- the technology can quickly scan containers -- and in China in the run-up to the 2008 Beijing Olympics. The stock sells for $74, or 19 times estimated '06 earnings.