While the definition of a sin stock remains unchanged, the range of companies categorised as such has expanded due to evolving societal views on what constitutes unethical or immoral business practices.
As socially responsible investing has gained popularity in the last decade, with a focus on environmental and social welfare, the term “sin stock” has expanded to include stocks that might have been considered more “grey” — such as fossil fuel companies and military defence contractors.
“It’s all very subjective; sin used to be defined by religion, but today politics seems to be more relevant [as a means to define sin],” says Professor Theo Vermaelen, professor of finance at Insead and the UBS Chair in Investment Banking.
Vermaelen once penned an article on the school’s thought leadership platform titled Doing Good by Investing in Sin, arguing that diverting investments away from “sin” does not necessarily improve the world.
Selling off a share in a company does not change the fundamental level of sin, says Insead Professor Vermaelen. Photo: Insead
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Like traditional sin stocks, the oil and defence sectors have been performing well recently. The S&P 500’s energy sector has risen approximately 17% this year, ranking second in performance within the index after communication services.
Shares of Marathon Petroleum have climbed 43%, Exxon Mobil shares have added 22%, Occidental Petroleum shares have gained 16% and Halliburton shares have jumped 13%.
“Sin stocks are doing well because when people don’t like something, the price will be low and undervalued. But the people who don’t care about bad feelings [when investing in] sin stocks make extra money,” says Vermaelen.
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Defending investments
The urgency of addressing the climate crisis has led to a series of scandals that ultimately resulted in increased investments in fossil fuels. For instance, a 2022 report by PwC projected fund managers to boost their environmental, social and governance (ESG)-related assets under management (AUM) from US$18.4 trillion in 2021 to US$33.9 trillion ($45.8 trillion) by 2026.
It was later revealed that US fund managers like BlackRock, State Street and the UK-based Legal & General were among the asset managers who used funds with ESG labels to invest in fossil fuel firms.
The fund manager, Legal & General, said it invested in fossil fuel firms to encourage their transition to more sustainable energy sources actively and argued that some coal mining businesses invested in renewable energy, and that with “active engagement” investors could speed up the shift away from fossil fuels., investors could speed up the shift away from fossil fuels.
As Israel continued its offensive on Gaza for nearly nine months and Russia maintained a full-scale assault on Ukraine for two years, defence stocks in the US and Europe surged. Global defence spending reached a record US$2.2 trillion in 2023, with European spending rising to US$388 billion, levels unseen since the Cold War, as the International Institute for Strategic Studies reported.
Still, the sentiment towards defence spending, especially in Europe, has turned positive following Russia’s invasion of Ukraine. “After the Ukraine war, most people believe that defence is not a sin and that giving weapons to Ukraine is very important, defending Europe is important. Why is defending yourself against aggression a sin?” says Vermaelen.
The Financial Times reported that demand for the sector has “clearly woken up”, with the fortunes of European defence contractors, including BAE Systems, Leonardo and Saab, rising to near-record highs of more than US$300 billion. BAE Systems saw its share price drive 188% higher over five years and has grown its earnings per share by 15% a year in the same time frame.
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Europe’s four main ammunition producers, including Britain’s BAE Systems, Germany’s Rheinmetall, France’s Nexter and Nammo and suppliers of explosives and propellants, including Chemring of the UK and France’s Eurenco, have also been winners.
Then, in the US, the world’s sixth largest weapons manufacturer, General Dynamics, saw its stock price hit a new 52-week high on June 3 at US$302.42. The stock previously closed at US$298.53. It supplies Israel with artillery ammunition and bombs for attack jets used in its assault on Gaza, according to the American Friends Service Committee, an organisation that promotes peace and social justice initiatives.
Northrop Grumman, known for supplying the Israeli Air Force with Longbow missile delivery systems for Apache attack helicopters and laser weapon delivery systems for fighter jets, secured a US$8.9 million contract for 30mm MK44 Stretch cannons funded by US taxpayers. Meanwhile, Lockheed Martin, a major weapons manufacturer providing armaments for aerial attacks on Gaza, was awarded a US$10.5 million contract to support the Israeli Air Force’s fleet of F-35 warplanes.
Unsurprisingly, the biggest shareholders of General Dynamics and Lockheed Martin are the same few names in the fund management space — Vanguard Group, BlackRock and State Street Corp, among others. But more interesting are Lockheed Martin’s biggest single shareholders, ex-CEO Marillyn Hewson, ex-vice president Scott Greene and former chairman of General Motors Daniel Akerson.
Ethical dilemmas
In late April, pro-Palestinian protests erupted at prestigious universities like Columbia, Harvard, Yale, and Princeton. Students demanded a permanent Gaza ceasefire, an end to US military aid to Israel, amnesty for disciplined protesters and university divestment from war-profiting companies.
At Columbia, students urged the university to divest from companies doing business with Israel, including Lockheed Martin. There is scepticism that ethical concerns about defence investments will prompt meaningful action.
Student campus protests against the ongoing conflict in Gaza “will not lead anywhere”, says Professor Sumit Agarwal from NUS. Photo: NUS
For one, Professor Sumit Agarwal, the Low Tuck Kwong Distinguished Professor of Finance, Economics and Real Estate at the National University of Singapore (NUS), believes that these calls for divestments by university students “will not lead anywhere”. “The students are not the investor base, and students don’t invest in stocks. The investor base [of these companies and funds] are old rich people who don’t care and want to profit from war, so the fund managers know these [protests] are useless,” he says.
Similarly, Vermaelen from Insead believes these protests will not materially impact the ongoing conflict. “These students should take a basic finance course. They should understand that when their universities sell their stocks, someone else will buy them, and the gun company will still supply guns to Israel,” he says. “All you’re doing is to lower the return of these pension funds, and if defence stocks beat the market, then the school makes less money, and it’s bad for the students in the long run.”
Calls to divest from companies supplying arms to Israel have seen limited success. On June 26, Norway’s largest pension fund said it would divest its stake in US industrial group Caterpillar over concerns that the company may be contributing to human rights abuses in the West Bank and Gaza. However, no US universities have currently committed to such divestments, as the war rages on for 260 days with over 37,000 casualties.
Vermaelen adds that investors who harbour ethical concerns about investing in defence-related stocks should know that the world would be terrible without defence stocks. He argues that selling off a share in a company does not change the fundamental level of sin, unlike when capital is invested directly through lending or investing in an equity issue or an initial public offering.
“That’s the difference between primary and secondary markets; you’re not a sinner because you don’t give money [directly] to a company, so selling sin stocks is counterproductive and does not make the world a better place,” he adds.
His advice for investors concerned about the ethics of investing in a defence company is not to own it. However, an alternative he proposes is to invest in the sin stock, exploit the undervaluation of the stock, take the profits and donate them to a social cause.
“That’s ethical behaviour, although it might sound different from what other people think is ethical,” says Vermaelen.
On the other hand, what is unethical is if a fund manager sells a fund to an investor that does not give good returns, the UBS Chair in investment banking adds. He argues that the financial manager’s responsibility is to invest in a positive net present value (NPV) project. If they “want to do good”, they should invest with their own money and not other people’s capital.
As war rages on, the viability of sin stocks as an investment will make the stock more attractive to investors who do not care about sin. Vermaelen, a portfolio manager in his free time who invests in Rick’s Cabaret, a strip bar in America, says: “At the end of the day, sticking to sin stocks is a good strategy as an investor.”
A tipping point?
Given societal and environmental pressures, could there come a tipping point where sin stocks are deemed unsuitable? Morningstar director of equity research (Asia) Lorraine Tan believes that for certain sectors, such as aerospace and defence, investors may also choose to apply different benchmarks for what they consider “acceptable”.
She adds that their investment decisions may depend on the significance of the defence element to the specific company. For example, aerospace companies Boeing and Airbus have defence businesses similar to ST Engineering. The defence businesses, however, make up around 30% of the companies’ profit, which is acceptable for certain investors as long as the company does not sell to certain governments, says Tan. “ST Engineering, for example, clearly states that it does not engage with China and Myanmar on defence equipment,” she adds.
Veronique Chapplow of T Rowe Price sees moves in the opposite direction. While defence companies were typically excluded from ESG-labeled portfolios, Russia’s invasion of Ukraine has prompted investors to reassess, considering national security and the defence of democracy.
Sweden’s SEB Investment Management, for instance, updated its sustainability policy shortly after the Russo-Ukrainian war escalated in 2022, allowing some of its funds to invest in defence companies.
Citing Morningstar data, Chapplow points out that nearly 800 sustainable funds in the UK and Europe had holdings in aerospace and defence in October 2023. She adds: “Finally, the European Union itself has indicated that the European defence sector plays an active role in protecting the continent’s borders, underscoring this change in sentiment.”
