The devil's disciple

ViceFund's Charles Norton guides us into the lucrative world of guns, smokes, booze and gambling stocks.-Dawn Calleja

How I do it
Globe Investor Magazine, May 22, 2008
Photograph by Allison V. Smith
Illustration by Ray Fenwick
Graph by Douglas Coull (Source: Bloomberg Financial Services)

Charles Norton has no vices-at least, none he'll talk about. To hear him tell it, he's just a family guy (with two kids and another on the way) who loves investing. It just so happens that the fund Norton manages focuses on the kinds of stocks many of us own (if only in a mutual fund), but don't own up to: tobacco, alcoholic beverages, gaming and defence.

"The concept is pretty simple, and it even sounds a little bit trite to say it, but people smoke and drink and gamble, and nations defend themselves, in good times and bad," says Norton, whose Dallas-based GNI Capital started managing the six-year-old ViceFund in 2005."so there are a lot of defensive characteristics to the portfolio, and it's also global in nature, so it's less sensitive to fluctuation than, say, the U.S. economy."

You can't actually buy the fund in Canada, which is a shame, since its five-year return is, well, sinfully good: an average of more than 20% a year. If you're set on sin, you can buy the FocusShares ISE SINdex exchange-traded fund (see box, below). or you can go the DIY route, using some of Norton's tips as a guide- that is, as long as you can stomach making money off companies that are nearly universally reviled.

Norton stresses that he didn't come up with the concept or the name. But when he and his business partner, Allen Gillespie, first began investigating the idea of managing the fund, they found huge gaps they could exploit."For whatever reason-social screening or whatever- there is a great deal of money that doesn't look at these sectors," says Norton. That's where GNI comes in.

Why vice is nice

At first glance, you might not see many links between tobacco, booze, gaming and defence, except that they're generally considered sinful. But the four have a lot in common. First and most important is the consistent demand for them, regardless of economic turbulence. Two, they're global in nature (one-third of ViceFund's portfolio is invested overseas)."If you travel outside the U.S., for example, one of the first things you'll notice is just how many people smoke," he says. Third, there are high barriers to entry, thanks to such factors as brand loyalty, economies of scale and access to distribution channels. And last, but certainly not least, they're all heavily regulated by government. In the case of defence, governments, too, are often big investors.

Emotion is the enemy

Norton and Gillespie stay away from the managers of the companies they cover. "I've seen it a lot of times- analysts fall in love with management, and it clouds their judgment. The same goes for stocks themselves. You know how it is- you buy a stock, you follow its ups and downs every day, even every hour. You firmly believe it's a winner, and darn it, you're sticking with it. Emotions are your enemy when you're trying to make money in this game, so we look at stocks objectively," says Norton. Alot of sector managers, Norton says, are bullish on their chosen industry every day of the year, no matter what. "We're different," he says. "our mandate is not to be bullish on each of these four sectors all the time; it's to be experts in them."

the best of the worst

The partners meticulously gather data on each of the four sectors ViceFund tracks, and then on each company within those sectors. "through our research, we develop a macro view of what's going on," says Norton. "What are the major trends in each of the sectors? then we go through each company and try to identify how they're positioned within that framework."

These days, the tobacco sector's got everything going for it. Cigarette stocks have almost always generated massive returns. according to a large study by Wharton school professor Jeremy Siegel at the University of Pennsylvania, Philip Morris, now part of Altria Group, has been the best-performing stock on the S&P 500 for the past 50 years. Norton won't be turning bearish on the sector any time soon; even after years of health warnings, litigation and bans, it's still smoking. "The legal environment is very benign right now," says Norton. And while more and more smokers in North America are butting out, cigarette makers can always jack up prices to offset the decline. Besides, even the threat of cancer has barely made a dent in smoking rates overseas, particularly in asia. "Globally, it's a story of volume growth," says Norton. "There are parts of the world where 60, 70, 80% of people smoke."

Gambling is also on the upswing internationally, which means big opportunities for such casino chains as the sands and MGM Mirage. "Macau is doing more gaming revenue annually than the Vegas strip,"says Norton. "But Macau is just Chapter 1 of a longer story about all of Asia embracing casino gaming."

In the U.S., casinos are starting to replace older slots with a new technology called server-based gaming. It allows operators to network machines, so they can track players' habits, run ads, change jackpots on the fly-a whole host of functions that boost profitability and efficiency. "It's going to be the must-have technology for casinos over the next five years," says Norton.

As for defence, waging war may not qualify as a vice, but it's certainly a growth industry. "We're actually in the middle of a supercycle that's being driven for the first time ever by three parts of the world: North America, Europe, and the Middle East and Asia," says Norton.

If you invest right, recessions don't matter

The looming recession in the United States has Norton particularly excited. It'll be the first real test of ViceFund's defensive strategy-after all, the stocks it holds are supposed to be recession-proof. "the ViceFund was launched in August, 2002, so it had only been around during a bull market, and that's typically when you would think that a defensive-type strategy would underperform," says Norton. That didn't happen. "this is our time at the ViceFund," he says. "When there's blood in the streets, these sectors really shine."