What it means
The idea is the opposite of ethical or socially responsible investing, where funds screen out industries that fail certain standards. A vice fund screens them in.
Managers choose companies with reliable sales in categories where customers keep buying through good times and bad. The investment case rests on a few points.
Demand for these products tends to be stable, regulation often limits new competitors from entering, and strong brands give the leading companies pricing power. Some investors also argue that if responsible investors sell these shares, the price falls and the remaining owners earn higher returns.
There are real risks. Governments can raise taxes, tighten advertising rules or ban products, and lawsuits can lead to large payouts.
A fund concentrated in a handful of industries also carries concentration risk, which means that a single piece of bad news can hit a large part of the portfolio at once. For institutions, the questions are as much about reputation as returns.
A pension fund, a university endowment or a charity may be bound by policies that prevent it from holding such shares, and a company-sponsored retirement plan may need to explain its choice to members. Many investors will accept a slightly lower return in exchange for avoiding the exposure.
The definition of a vice varies by person and by country. Some funds include only tobacco, alcohol and gambling, while others add defence and adult entertainment, so you should always read the fund's stated rules before assuming what it holds.
Past performance of such funds has varied, and no sector is a guaranteed winner. Fees, concentration and the narrow universe of eligible companies all affect results.
Whatever a person's view on the ethics, the sensible test is the same as for any fund: what does it hold, what does it cost, and does it fit the investor's goals?
In practice
Real-world examples.
Example
A private investor in Dubai wants to add a small allocation of 5% to defensive consumer shares with high dividends. His adviser shows him a vice fund and explains the sector risks, and he decides that his personal values make it unsuitable.
Example
A hedge fund analyst compares a gambling operator with a technology company. She notes that the operator's revenue held up during the last downturn, but that a change in licensing rules in one country could remove a fifth of its profit.
Example
A charity's investment committee reviews its policy after a donor complains. The committee concludes that its portfolio must exclude tobacco and gambling, and it instructs its fund manager to replace any such holdings within six months.
Formula
Calculation
Portfolio return = sum of (weight of each holding x return of that holding)
A vice fund holds four groups of shares. Tobacco is 30% of the fund and returned 10%, alcohol is 30% and returned 8%, gambling is 20% and returned 12%, and defence is 20% and returned 6%. Portfolio return = (0.30 x 10%) + (0.30 x 8%) + (0.20 x 12%) + (0.20 x 6%) = 3.0% + 2.4% + 2.4% + 1.2% = 9.0%. On an investment of $1,000,000, the gain is 1,000,000 x 0.09 = $90,000.Case study
Seen in the real world.
Ashgrove Capital is an illustrative, fictional asset manager that launched a vice fund with $50,000,000 from investors. Its mandate was to hold 25 to 30 companies across tobacco, alcohol, gambling and defence, and to avoid any single holding above 6%.
In the first year, the fund returned 9%, slightly ahead of a broad stock index at 8%. In the second year, a tax increase on tobacco and a regulatory fine on a gambling operator pulled the fund down 5% while the index rose 4%.
The illustrative lesson was that the performance came with concentration risk. The fund's managers began to cap each sector at 30% of assets and added more holdings in each group, so that no single regulatory decision could cause too much damage.
Watch out
Common mistakes.
- Assuming vice stocks are always safe because people keep buying the products, when tax and regulation can change quickly.
- Assuming all vice funds hold the same industries, when the definitions differ from one fund to another.
- Ignoring how a holding fits the investor's or organisation's own policies, which may rule these shares out.
Questions
People also ask.
Do vice funds really outperform?
Sometimes they do and sometimes they do not, and results depend on the period measured, the fees charged and the choice of companies.
Is a vice fund illegal?
No, it is a legal investment, but some investors choose to avoid it for ethical reasons or because of their own investment rules.
Why do some investors prefer these funds?
They are attracted by steady demand and strong brands, and by the argument that shunned shares can offer higher returns.
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