Risk, Return, and Reputation: A Comparative Study of Sin Stocks and ESG Portfolios in the European Equity Market

European asset managers hold more than two trillion euros in formally labelled sustainable funds. Yet, seminal research evidence from Hong and Kacperczyk (2009) suggests that equities shunned on ethical grounds, so-called sin stocks systematically outperform in U.S markets. In this thesis we ask whether the same shunned-stock premium persists in Europe, whether ESG outperforms the broader European equity market, and lastly if said sin premium lasts in Europe’s ESG-regulated environment across different market periods. We construct two equal-weighted sin-portfolios: Traditional (tobacco, alcohol, gambling) and Extended (including coal and arms). Additionally, two ESG-portfolios comparators based on high and low levels of ESG-stringency: ESG-Select and ESG-X derived respectively from STOXX Europe ESG leaders Select 30 and STOXX600Europe ESG-X. All four portfolios are benchmarked on our broad European equity market index: STOXX600 Europe. Monthly returns covering a total span from July 1998 to April 2025 are evaluated using CAPM, Fama-French 3 Factor, Carhart-4 Factor and Fama-French 5 Factor model, supplemented by key portfolio metrics, and subperiod tests (Pre-COVID, COVID Era and ESG Momentum). Results show that both sin-portfolios consistently generate significant positive alpha in the broader equity market, while ESG-portfolios underperform across models and periods on the same benchmark. The sin premium exhibits context-dependent variation: it reaches statistical significance during the COVID Era but loses significance during the ESG Momentum window. This study extends Hong and Kacperczyk's (2009) U.S. findings to the European context, demonstrating that the shunned-stock premium persists even in markets with institutionalized ESG norms, while revealing that the premium's magnitude depends on market conditions and ethical exclusion stringency.