- Associated Press - Sunday, August 22, 2010

BOSTON | So much for virtue. Sin is in.

That’s according to a mutual fund manager who’s finding plenty of investment opportunities in companies profiting from vices like smoking, drinking and gambling.

Jeff Middleswart’s aptly named “Vice Fund” is beating the house in a down market. The Standard & Poor’s 500 index is down 1.9 percent this year. Yet stocks of cigarette makers are up an average 12 percent.

The Vice Fund’s three biggest holdings are cigarette stocks: Philip Morris International Inc., Lorillard Inc. and Altria Group Inc. That explains why the fund is up 4.5 percent this year, ranking in the top 3 percent of its fund peers, according to the rating service Morningstar.

Defense contractors - another fund mainstay - are up an average 12 percent. Alcoholic beverages? Up 6 percent.

Vice is the lifeblood of a fund that’s a counterpoint to investment products touting themselves as “socially responsible” because they favor companies ostensibly promoting the greater social good. This year, those stocks aren’t doing anything special. An index of socially responsible stocks is down 1.7 percent for the year.

While things are looking up in 2010, Vice Fund (VICEX) is rebounding from lagging returns in 2008 and 2009. Its turnaround would be even bigger if not for the average 30 percent decline for stocks of gambling companies. They’re struggling to cut hefty debt loads, a legacy from years of casino-building.

Vice is the only fund explicitly focusing on sin stocks. Its portfolio of about 30 stocks is divided almost equally among cigarettes, alcohol, gambling and casinos, and defense - industries that typically hold up well in tough times. Although such a small portfolio can lead to volatility, the Vice Fund offsets that risk by emphasizing steady, dividend-paying stocks.

Mr. Middleswart replaced previous manager Charles Norton in February, after more than two decades as an investment analyst. The 40-year-old Dallas resident manages the eight-year-old fund for USA Mutual Funds, along with the smaller Generation Wave Growth Fund, which invests in stocks expected to profit from spending by baby boomers.

In an interview, he showed little reluctance to focus on companies and stocks that some investors might shy away from for moral or social concerns.

“I’ve always been a contrarian,” he said. “If you listed everything you look for in a stock - companies with growing cash flow, that pay dividends and buy back shares and have clean balance sheets - you’d find a huge list of sin stocks.

“Yet people look at them and say, ‘I don’t want to own that, it’s tobacco, it’s an industry that’s going out of business.’ Or they say, ‘I don’t want to own an alcohol stock.’”

Because some of investors have qualms that have nothing to do with the financial value of the stocks, “we’re getting them at a discount,” he added.

Despite the strong public campaign against smoking, he noted, companies like Philip Morris are still growing, especially overseas.

“In emerging markets, people are smoking more, and they’re going for brand-name cigarettes,” he said. “With this stock, you’re getting a dividend yield of nearly 5 percent, and they also have enough cash flow to buy back shares.”

“You’ve got a company that doesn’t have to spend a fortune every year remaking itself, in terms of research and development, and signing new distribution agreements.”

Asked if he patronizes the stocks he invests in, Mr. Middleswart said, “I will have a glass of wine or drink a beer, but my gambling mostly consists of a couple days a year at the horse track. I’m more likely to go hiking or run on the treadmill than anything else.”



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