Published March, 2003

A Sinful Delight: Cashing in on Vice!

Last month, we highlighted the "responsible" investor, one attempting to construct a portfolio consisting only of companies deemed to improve the quality of life. But, what about investors with more-devilish appetites? A "socially responsible" portfolio does not necessarily guarantee the best results. In fact, amid the stock market's recent hardships, many of these "clean" funds have seen their long-term results diminish and lag the S&P 500 Index. Some other types of funds, however, have found a different road to travel, and have bet on "sin."

The idea behind "vice" investing is simple: Certain "irresponsible" industries, such as alcoholic beverages, are recession-proof, and people will indulge in their goods and services in both prosperous and abysmal market environments. In August of 2002, Dan Ahrens and Eric McDonald of the Dallas-based research and investment firm MUTUALS.com Inc. took this idea further and created the "socially irresponsible" Vice Fund. One of the first of its kind, Vice Fund has drawn much attention, garnering an influx of nearly $4 million in total net assets in its six-month history, a period where skepticism was still apparent and many pulled back on their investments. Although some have labeled the fund politically incorrect, it was created on the premise that these names should not be shunned because of their industries, because they generate strong returns.

For co-managers Ahrens and McDonald, the strategy begins with the four main vice industries: alcohol, aerospace/defense, gambling, and tobacco. Typically, the distribution of assets will be close to even among the four sectors, but the fund's flexibility enables it to vary the weightings according to current trends.

Alcohol, the first of the forbidden areas, is favored because the brewers and wine and spirits producers are operating in a favorable pricing environment, and consumption continues to rise. Within Vice Fund, Ahrens points to its top alcohol positions, Anheuser-Busch and Diageo, as perfect examples: They have both continued to increase their market share despite their dominant industry positions.

Aerospace/Defense names are also on the list. They employ millions of Americans and greatly contribute to the U.S. economy. According to management, this area will only improve once a final decision is made, either way, regarding the U.S.-Iraq conflict. Its top position there, United Technologies, is expected to post predictable earnings, a rarity in the recent environment.

According to Vice Fund research, the third taboo category, gambling and casinos, was one of the best-performing industries in the five-year span ended June 2002. Although casino revenues may be disappointing in 2003, the long-term potential of companies such as MGM Mirage has encourages management, as do expectations that gambling cruises, online betting, and the growing support of government-run lotteries by publicly traded companies will only boost the gaming industry.

The last of the four "sin"dustries, tobacco, has drawn a significant amount of criticism. Although domestic consumption has declined, and the overwhelming number of highly-publicized litigations has shattered public perception, the area shows promise because of its international success. Ahrens cites British American Tobacco and Altria Group as two companies that have been able to expand with the growing demand overseas.

With the pool of candidates limited to these four sectors, management then runs individual stocks through further screens. For Ahrens and McDonald this includes both growth- and value-oriented issues, with investments ranging across all market-caps, although, generally, large-cap industry leaders dominate the portfolio. The bottom-up selection utilizes fundamental and technical analysis, searching for characteristics such as strong balance sheets, experienced management, and attractive intrinsic values.

Investors looking to capitalize on sin by building their own vice portfolio can, like Ahrens and McDonald, use the four sectors to make selections. To start, they can use Vice Fund research for assistance, by visiting www.vicefund.com, where, each month, a strong-performing vice stock is highlighted, covering all aspects of the company's business. Additional help can be found in The Value Line Investment Survey, which not only provides full industry analysis for each of the four sectors, but provides individual stock analysis, as well.

Having gone through one of the most-difficult bear markets in history, investors are facing many challenges. If they believe, as Ahrens and McDonald do, that vice industries thrive in all markets, then a "socially irresponsible" portfolio may be a sinful delight.