Casino, tobacco, alcohol stocks beat market

The Dallas-based Vice Fund has left political correctness to others and boldly gone where other mutual funds fear to tread — Sin City.

The four-year-old Vice Fund invests in casino stocks and in companies that make liquor, tobacco and bombs.

Given people's proclivities to drink, smoke, gamble and blow each other up, no matter the economic climate, it should come as no surprise the Vice Fund has been a consistent top performer.

It has beaten the Standard & Poor's 500 index in each of the past three years and is on track to repeat this year.

The Vice Fund holds Morningstar's highest five-star rating and over the past year ranks 22nd out of the 174 mutual funds that invest in midsize growth and value stocks.

"We have a history of outperforming the market," said Charles Norton, co-portfolio manager of the Vice Fund and principal at GNI Capital. "You soon realize that there is true investment merit in these sectors."

Merit indeed. Cigarette maker Altria Group, the fund's largest holding, is up about 33 percent over the past 18 months.

Another holding, London-based Diageo, which makes and distributes wine and spirits — including Johnnie Walker Scotch and Smirnoff vodka — is up about 32 percent for the same period.

In the gaming sector, one of Norton's favorites is Las Vegas Sands, which has doubled.

He says these sectors should perform even better — relative to the overall market — if the economy slows. as most financial experts predict. That's because people will smoke, drink and probably gamble during a recession.

The defense sector is essentially tied to the U.S. military budget and moves independently of U.S. economic cycles. But given the current geopolitical turmoil in the Middle East, no one is projecting big budget cuts in defense.

"Based on historical precedent, right now is the most opportune time to be invested in this fund," Norton said. "The reason is we are at an inflection point in the economy. We are already seeing signs of softening in the economy."

Not everyone shares this enthusiasm for the fund.

Hugh Johnson, chairman of Johnson Illington Advisors in Albany, N.Y., said although it's true sin sectors have outperformed the broader market in recent years, there's no assurance that will continue.

"The Vice Fund clearly has hit it right recently, where all four of those sectors are doing well at the same time," he said. "The odds are against that working all the time."

Further, Mark Luschini, head of asset management at Parker Hunter, a Pittsburgh money-management firm, said these four sectors are by no means all of the defensive plays.

Health-care stocks, utility stocks and other consumer staples, such as soft-drink companies and household products, should hold up reasonably well if the economy slows.

"The Vice Fund seems to be pretty narrowly focused," Luschini said. "I would be a little shy of being that tightly focused. You are leaving out a lot of prominent industry sectors."

Norton said, however, there are hundreds of companies to choose from in those four sectors, so "it's pretty broad-based."

Further, he said there are more nuanced strategies in vice investing than just playing on human weaknesses.

First, there are high barriers of entry into the sectors. For example, a limited number of gaming licenses are issued, and "you are not seeing any new tobacco companies that are starting up," Norton said.

Second, companies in these sectors are highly profitable, with excellent cash flow and solid management.

Third, many of these vice stocks, especially the distillers and tobacco manufacturers, have substantial overseas operations. Some Asian countries are opening up to U.S. gaming companies.

Las Vegas Sands is becoming "the most prominent player in the Asian gaming market, which is extremely fast-growing," Norton said. "There is even talk that Japan is going to allow casinos there for the first time."

Tobacco companies have faced litigation for years, but analysts say the legal risks are subsiding.

Tobacco companies have won three major legal victories over the past year, including the Florida Supreme Court upholding a decision to negate a $145 billion judgment. This was one of the last class-action cases involving the industry.

And finally, alcohol, tobacco, gaming and defense industries have been around for hundreds of years.

Fads come and go, but people will probably always engage in those activities, he said.

"In the case of the alcohol and tobacco industries, those products are never made obsolete by new technology," Norton said.

The Vice Fund, which has about $53 million in assets, is the only mutual fund tracked by Lipper that focuses solely on sin stocks.

The fund has the option of investing 20 percent of its assets in sectors other than those related to vice, but currently it doesn't. The minimum investment is $4,000.

Obviously, some investors have moral objections to investing in these kinds of industries. There are so-called socially conscious mutual funds that won't buy any sin stocks.

Norton said although he is respectful of their objections to these sectors, all of the activities are legal.

"It is sometimes misunderstood that we are advocates of smoking and drinking," he said. "The fact is we are not making any social commentary on that at all. They are products being sold, and it is our job to analyze the fundamentals."

Many mutual funds own shares in tobacco, gaming, alcohol and defense companies, Norton said.

"We just happen to focus on these sectors because we believe they offer true investment merit," he said.