Gerry Sullivan at USA Mutuals says there’s a price to pay for ethical investing, or any strategy that values both social performance and financial returns.

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His Vice Fund, which invests evenly across tobacco, alcohol, gambling and weapons companies, has outperformed the average socially responsible investment (SRI) fund in all but two of the past 10 years.

Vice companies aren’t recession-proof, Sullivan says, but they hold up better during hard times because people continue to consume those products in similar amounts. He adds Apple nearly qualifies because “there is an addictive element to its devices.”

He sees grey areas in ethical investing. He understands why teachers’ pension funds spurn tobacco, but not why Norway’s sovereign-wealth fund divested Walmart over labour practices. “Walmart has social value because it brings products within reach of the low and middle classes.”

He admits the Vice Fund is a tough sell. “People think a fund with a salacious name isn’t serious, but it offers a compelling opportunity for high profit” from anti-cyclical industries.

Bob Walker, who oversees Ethical Funds at NEI Investments and launched the first SRI fund in Canada in 1986, hasn’t heard anyone speak seriously about vice funds in years.

“The vice style of investing is not in the same league as SRI,” he says, because it hasn’t attracted significant assets. Sullivan’s Vice Fund has $111.7 million in AUM, much smaller than the average U.S. SRI fund, which has about $1.4 billion AUM. And the United Nations-backed Principles for Responsible Investment (PRI) initiative has more than 1,000 investment institutions with more than $30 trillion AUM.

RBC Global Asset Management says one out of every five dollars under professional management in Canada has some SRI mandate.

For NEI, ethical investing means buying companies with good environmental, social and governance (ESG) practices. It believes these can lead to long-term outperformance. Morningstar gives NEI’s Ethical Global Dividend and Special Equity funds four stars each, and the NEI Ethical Global Dividend Fund achieves first-quartile performance. (The Vice Fund also has four stars.)

“Most mainstream investment managers migrating toward SRI [i.e., PRI signatories] aren’t incorporating these strategies out of the goodness of their hearts,” Walker says. “They are doing it because these practices help provide higher risk-adjusted returns.”

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Not all companies NEI owns meet the highest ethical standards. “They meet our baseline expectations for ESG performance,” Walker explains. “It is then our job as ethical investors to encourage them to perform better.” NEI divested Great-West Lifeco this year because the company failed to address business risks associated with climate change.

Ethical Funds believes engaging companies on ESG issues is more effective for influencing corporate performance than using exclusionary screening. For example, mining companies that operate where human rights violations are prevalent must demonstrate they’re not complicit in violations.

One of its biggest successes in changing corporate governance was getting RIM’s board to adopt a policy dividing the role of chair and CEO in 2011.

Advisors interviewed for this story say that when a client raises an SRI question, it usually concerns tobacco or the environment. Some don’t want tobacco companies because they’ve lost a loved one to lung cancer. Others don’t want companies in the Canadian oil sands because they cause environmental degradation.

But advisors are often reluctant to broach ethical questions with their clients, seeing these questions as morally and politically sensitive. Even so, Martin Grosskopf, VP and portfolio manager, director of sustainable investing at Acuity Funds, says investors have become more politicized since the crisis. “There was a tremendous social element to the financial collapse, which has caused a resurgence of interest in companies providing solutions; people want to invest in something sustainable over the long term.”

Acuity’s Clean Environment and Social Values funds screen financially for growth companies benefiting from ESG trends.

Grosskopf likes Secure Energy Services, a company recycling oilfield wastewater in Alberta. “It’s ideal for us: it has a high growth rate, we’re comfortable with management and governance, and it creates a lot of jobs.” He adds he owns it even for investors with no interest in SRI.

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He says there’s no opportunity cost to owning responsible companies, at least not on a risk- or conscience-adjusted basis. Grosskopf adds it’s short-sighted to invest in traditionally defensive vice stocks as economic conditions, regulations and longer-term social trends change, even though some, like tobacco, have done well by paying out much of their earnings in dividends.

Paul Nash is a Toronto-based financial writer.