Abstract
We examine the impact of excluding sin stocks on expected portfolio risk and return. Exclusions involve risk relative to the market and peers. We show how this tracking error can be translated into an equivalent loss in expected return, which is negligible at low tracking error levels, but not at higher levels. However, even modest ex ante tracking error levels may lead to sizable compounded underperformance ex post. Taking an asset pricing perspective we find that popular exclusions typically go against rewarded factors such as value, profitability, and low risk, which is harmful for expected portfolio returns. Theoretically sin itself may also be a priced factor, but this is not yet supported by the empirical evidence. Tracking error may be minimized and expected portfolio return restored by filling the gap left by excluding sin stocks with non-sin stocks that offer the best hedging properties and similar or better factor exposures.
Original language | English |
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Pages (from-to) | 1693-1710 |
Number of pages | 18 |
Journal | Journal of Sustainable Finance and Investment |
Volume | 13 |
Issue number | 4 |
Early online date | 3 Sept 2021 |
DOIs | |
Publication status | Published - 3 Sept 2023 |
Bibliographical note
Funding Information:The views expressed in this paper are not necessarily shared by Robeco. We thank Guido Baltussen, Bart van der Grient, Jan Anton van Zanten and other colleagues at Robeco for valuable feedback.
Publisher Copyright:
© 2021 The Author(s). Published by Informa UK Limited, trading as Taylor & Francis Group.