'Sin' Stocks Help Investors Escape Slump

BOSTON ( TheStreet) -- Vice always comes at a price, but given the economic tumult, the historically defensive "sin" stocks of gambling, alcohol and cigarette companies are struggling, despite their well-earned reputation as recession-proof.

That's because consumers have cut back on discretionary spending as they fret over job security, and a slew of new taxes prices life's little pleasures out of the reach of many wage earners.

Even the stocks of defense contractors, lumped into the "vice" category by politically correct do-gooders, are under the gun because of Congress' avowed efforts to cut spending across the board to trim the deficit in a plan hashed out a week ago.

Gerald Sullivan, manager of USA Mutual's Vice Fund ( VICEX), a 42-company portfolio made up of the stocks of only four industries -- cigarettes, alcohol, gambling and aerospace/defense -- said his portfolio will weather the downturn better than the S&P 500 Index, as it has previously, and will then outdo them when prosperity returns.

Sullivan said the fund's portfolio mix is diverse enough to offset one another, providing a less-volatile and, therefore, more predictable performance.

The Vice fund has fallen 5.8% over the past three months, about half that of the S&P 500 Index in what is the longest losing streak in two years. But the fund is up 6.5% this year, while the S&P is down 3.5%.

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In an example of the challenges the cigarette industry faces, New York state recently raised excise taxes on a pack of cigarettes by $1.60. Marlboros now sell for $14.50 a pack in midtown Manhattan. Elsewhere in the U.S., it's half that.

But providing some sort of redemption for sin stocks is international demand. Growing middle classes in Russia, China and India have more money to spend, which has increased their appetite for cigarettes, alcohol and gambling. And they're also trading up from cheap, local brands to major international brands, which they perceive as being of higher quality and more prestigious.

The Vice fund's top beverage-industry pick is Diageo ( DEO), a London-based firm with eight of the world's top 20 brands and an unrivaled global distribution platform that spans 180 countries. It's expected to earn $5.09 per share in fiscal 2011 and $5.57 per share in 2012. The company's top brands include Smirnoff, Johnnie Walker, Jose Cuervo and Guinness.

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