Drink, Smoke and Gamble, and This Fund Climbs

Gambling and casino stocks have risen steeply this year, in another sign that some that some pastimes never go out of style. Brian Branch-Price/Associated Press.

July 9, 2006

By JOSHUA BROCKMAN

More than 150 mutual funds call themselves socially responsible, investing only in companies that meet a series of ethical standards set by their fund managers. Then there’s the Vice Fund.

Its prospectus says it favors “products or services often considered socially irresponsible.” The fund has fulfilled that promise under several different fund managers, investing mainly in companies involved with alcohol, tobacco, gambling and military contracting. This politically incorrect approach has helped the Vice Fund outperform the Standard & Poor’s 500-stock index from its inception in 2002. But the fund has had more than its share of management turmoil.

In 2003 and 2004, civil and criminal charges were brought against three executives of the fund’s former adviser, Mutuals.com, in connection with market timing. One of the executives, Eric McDonald, was also the co-manager of the Vice Fund. All of those charges are still pending, including civil charges against Mutuals.com and two broker-dealers affiliated with it, Connely Dowd Management and MTT Fundcorp.

A special monitor appointed by a federal court remains in place for Mutuals.com and all its affiliates, including the Vice Fund, to ensure compliance with securities laws.

When Mr. McDonald stepped down from the Vice Fund, he left Dan S. Ahrens as its sole manager. Then, in August 2005, Mr. Ahrens left the fund because of disagreements stemming from the charges against the other executives, he said. In March, he started the Gaming and Casino fund, which has a more narrow focus, concentrating on gambling, casino and lottery companies — politically incorrect territory it shares with the Vice Fund.

The Vice Fund, now managed by Charles L. Norton, 32, and Michael J. Henry, 26, has stuck to its knitting. Both funds depend on the insight that stocks that exploit the dark side of human nature are a natural for Wall Street, particularly during economic downturns. This philosophy is articulated in Mr. Ahrens’s book, “Investing in Vice,” (St. Martin’s Press, 2004).

“Certain habits, even during bad economic times, don’t change,” Mr. Ahrens wrote. “No matter what the stock market is doing, people still indulge in what are known as vices: smoking, drinking and gambling.” Mr. Ahrens added war to the list, calling these sectors good long-term bets.
Lately, the approach has again been paying off. Gambling and hotel casino stocks returned 25.3 percent this year through Thursday and 28.9 percent, annualized, in the last five years , according to Morningstar. The S.& P. 1500 Casino and Gaming Index, which tracks 10 stocks from the 1500 index, was up 10.1 percent through Thursday and 21.4 percent, annualized, over the last five years.

Tobacco stocks posted annualized five-year gains of 20 percent, while those for alcoholic beverages gained 12 percent a year and the aerospace and defense sector, including military contractors, climbed 11.8 percent, according to Morningstar.

The Vice Fund returned 9.2 percent this year through Thursday, compared with 3.1 percent for the S.& P. 500. Over the last three years, the fund’s return has been 20.6 percent, annualized, outpacing the 10.9 percent of the S.& P. 500. The fund has no load, or sales charge, and has an expense ratio of 1.75 percent. Its allocations as of May 31 included roughly 27 percent to casinos, gambling and lotteries; 24 percent to aerospace and defense; 24 percent to alcohol; and 21 percent to tobacco.

From inception in March, the Gaming and Casino fund gained 0.8 percent through Thursday.

Funds that call themselves socially responsible take a very different approach, of course. “We have a zero tolerance for weapons, alcohol, tobacco, gambling,” said Christopher H. Brown, portfolio manager of the Pax World Balanced fund, which has more than $2 billion under management, roughly 40 times as much as the Vice Fund. Pax World Balanced returned 2.8 percent this year through Thursday; 10.2 percent, annualized, over the last three years; and 5.1 percent over the last five.

The Vice Fund has not experienced a “full business cycle,” Mr. Brown said, so “it remains to be seen how they do in the long run.”

The Vice Fund’s aerospace and military portfolio includes some companies that have had financial windfalls because of the war in Iraq, said David Strauss, an equity analyst at UBS Investment Research. General Dynamics, which manufactures armored vehicles, is a case in point, he said. “Historically, the defense company stocks have performed fairly well in a period of weak economic growth,” he said.

Of course, scores of mutual funds have big dollops of certain holdings of the Vice Fund in their own portfolios. “I think what they’ve done is taken a good marketing spin to the consumer discretionary sector,” said Philip Edwards, S.& P.’s managing director of fund research.

Mr. Norton, one of the current co-managers of the Vice Fund, says he favors quantitative analysis in evaluating companies for its portfolio. He is married and has two children, and says he may be at a bit of a disadvantage when it comes to hands-on research for the fund.

“I drink socially, but not regularly,” he said. “I don’t smoke. I only gamble when I go to Vegas.” But he said he had a more rollicking lifestyle as a student at Tulane University in New Orleans. “I do have some experience in the sector,” he said.

Jeff Tjornehoj, an analyst for Lipper, credits the Vice Fund for not focusing “entirely on household names, which tend to be large companies.” Some of its more off-the-radar investments include the Central European Distribution Corporation, a Polish importer of alcoholic beverages; CryptoLogic, which supplies Internet gambling software; and Viisage Technology, which provides facial recognition security technology.

The Gaming and Casino fund, which has an expense ratio of 1.7 percent and no load, according to its prospectus, does not have much of a track record yet, but Mr. Ahrens says its portfolio includes a variety of casino, gambling and lottery stocks, including Las Vegas Sands, Penn National Gaming, Scientific Games and Shuffle Master.

At the Vice Fund, the run of frequent management changes isn’t over yet, Mr. Norton said. The fund’s current adviser, Mutuals Advisors, plans to outsource management of the fund to GNI Capital, an investment adviser based in Greenville, S.C., he said. A second fund, Generation Wave Growth, of which he and Mr. Henry are co-managers, will also shift to GNI Capital, he said. Mr. Norton said he planned to remain a co-manager of both funds. Allen R. Gillespie, a principal at GNI, will replace Mr. Henry at both of them, he said.

The civil and criminal charges against the former executives of Mutuals.com were filed by the S.E.C. and the United States attorney for the Southern District of New York. In addition to Mr. McDonald, Richard A. Sapio and Michele Leftwich were charged.

In December 2003, the S.E.C. filed a civil complaint accusing them of market timing and defrauding investors. In March 2004, the United States attorney charged the three with conspiracy to commit securities fraud. Later, in August, those charges were expanded to include wire and mail fraud.

None of the charges involve the Vice Fund directly. According to the Vice Fund’s prospectus, Mr. Sapio controls Mutual Capital Alliance, the parent company of Mutuals Advisors.

“We are negotiating with both the Department of Justice and the Securities and Exchange Commission,” said William M. Ravkind, Mr. Sapio’s lawyer. “The judge has been allowing us time to see if we can have some agreement.”

Read original article, which appeared in Section 3 on p. 6.