ESG and Sin Stocks: An Empirical Analysis of Sustainability in Controversial Industries

Abstract

As sustainability has become a fundamental consideration in modern society, ESG principles have gained strong traction in financial markets. This thesis investigates how ESG factors impact the risk-adjusted returns of companies in controversial industries, the so-called sin stocks. The research question guiding this study is: What is the relationship between ESG, E, S, and G scores and financial performance for traditional and new sin stocks, respectively? “Traditional” sin stocks refer to companies involved in alcohol, tobacco, gambling, and weapons/defense, while “new” sin stocks include those operating in oil and gas, coal, and uranium. The aim is to assess whether sustainability considerations systematically influence returns in these industries, and whether the market rewards or penalizes firms based on their ESG performance. Two primary analyses were conducted. Firstly, portfolios of traditional and new sin stocks were constructed based on high/low ESG, E, S, and G scores, with annual rebalancing and performance evaluated through FF3- , CH4-, and FF5-models between 2011-2025. Secondly, long-short strategies were employed to isolate the effect of ESG performance. Results indicate that ESG ratings do not consistently serve as a source of superior risk-adjusted returns. Among traditional sin stocks, no significant alphas were found, and although some low-ESG portfolios achieved higher Sharpe Ratios, these differences were not statistically robust. Long-short strategies showed negative but insignificant alphas, suggesting that 'best-in-class' ESG investing has not yielded superior returns in this group of sin stocks. In contrast, low ESG performers were penalized more heavily for new sin stocks, with significantly negative alphas observed. Long-short portfolios based on E- and S-score demonstrated positive and significant alphas, highlighting the environmental and social dimension as potential sources of excess return. Sub-period analysis of 2011-2019 and 2020-2025 revealed that ESG is highly context- and time-dependent. Overall, ESG appears increasingly integrated into market pricing, reducing the scope for systematic outperformance but allowing investors to allocate sustainably in sin stocks without sacrificing risk-adjusted returns.