How can you tell which sectors will benefit from a bill’s passage? Look at the votes of senators with the biggest vested interests.

Election_CheckWall Street obsessively monitors Capitol Hill, and with good reason: the slightest tweak in a bill’s language can boost–or bludgeon–corporate profits. But investors often struggle to predict how government actions will impact stocks. Take, for example, the Affordable Care Act. Market sentiment towards the bill oscillated wildly in the months leading up to its passage. Some investors are still confused about whether the law will benefit drug makers, medical device companies, and insurers.

Most bills are complicated, and it isn’t always easy to anticipate whether they will help or hurt stocks. But a new study from the National Bureau of Economic Research by Lauren Cohen, Karl Diether, and Christopher Malloy offers a simple solution. The researchers posit that investors can forecast the effect that legislation will have on a sector by looking at the Congressmen who are voting for it. If the bill has garnered support from senators who hail from states where the relevant industries have a strong presence, then you should buy those industries after it passes. If the same senators oppose the bill, short the sector.

The researchers analyzed votes cast by senators on approximately 6,000 bills between 1989 and 2008. They singled out the industries that were mentioned in each bill, and then classified senators as “interested” if those industries were concentrated in their home states. If the ratio of “interested” senators voting in favor of the bill was greater than the ratio of “uninterested” senators, they bought the sector and held it for a month. If the ratio of “interested” senators voting against the bill was high and it passed, they shorted the sector.

Their strategy worked. The basic long-short portfolio they created generated risk-adjusted returns of 11% a year over the course of two decades. The S&P 500 returned about 8.3% a year in that time.

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Source: Mina Kimes | Fortune