Tobacco Investment Contingent Liabilities

Walking into Great Westerford this morning on a crisp sunny Cape winter morning I was surprised to find huddles of smokers grabbing a puff on the steps. A beautiful day, puffing away. But maybe not that much different than those who need their 'morning cup of Joe' to start their day. The human habit of smoking is a fascination: humans choosing to buy a product directly linked to disease - including my two sisters whose own grandparents died from lung cancer and cardiac failure linked to chain smoking. Help explain how this logic stacks up: tobacco is a non-nutritious agricultural industry product driving farmers to farm cash crops not nutritious foods for sale to multinationals to sell to humans as aspirational good living to smoke and will in time directly lead to negative health impacts. Any investor integrating ESG factors must be investing away from tobacco. One may make an investment case and an ethical case. Either way, it raises all the classic considerations in sustainable finance and responsible investment: 1. whose money is it, 2. what is best practice investment analysis, 3. are all the investment factors covered [including environmental, social and governance ESG factors] and 4. what time horizon is long term? The decision to invest in tobacco must be a litmus test for any work on ESG architecture. Is it being discussed by the large ICGN or smaller PRI at their annual meetings this week in Sydney? Bill Gates and Michael Bloomberg in January 2009 put some of their personal fortune [USD 50m] into combating smoking, but I wonder if their endowments have? Any investment practitioner who is tasked with integrating ESG factors sooner or later will be faced with a tobacco name in the portfolio holdings or investable universe. In South Africa this morning, longtime investment writer Ben Temkin, originally a stalwart at Financial Mail and now at Business Day, covered his position on BAT, British American Tobacco, cross-listed in London LON: BATS and on Johannesburg Stock Exchange. Check the BAT investor presentations here for their take on the contingent liabilities, or the lack thereof. Thank you for smoking.

BAT is considered a "blue chip" investment name for many years and a large part of the Rembrandt/Richemont/Remgro story that is now playing out again as the Rupert family heading the companies consider re-bundling what they unbundled. A Business Day reader who follows Ben's Private Investor column that offers some investment thinking and breaks down the investment opportunities of the day, challenged him on the "fundamentals" that a tobacco firm offers as an investment opportunity. The reader challenges Ben by saying he has a declared bias against investing in tobacco, that if the same numbers reflected the financials of say, a retailer, that Ben would be making different recommendations. In effect the reader is making an ethical case: investor should suspect looking behind the numbers. Perhaps Ben has had a tobacco-related illness cause personal tragedy, similar to a money manager of a multi-billion dollar shop just off Wall St leading a large fixed income team; who invited his staff to bring all investment ideas forward but never bother to bring forward a tobacco deal on account of losing a parent to tobacco-related illness. Knowing that the product of a firm is directly linked to ill health does create an ethical crisis for its business partners, including investors. How they choose to deal with the ethical dilema is their liberty to choose. The Independent's Warner stated it plainly in 2006 "Jeremy Warner's Outlook: Investing in tobacco may be unethical, but it sure is lucrative, as Gallaher bears witness". What was it about 2006, articles pitching the sector were also on MSN Up in smoke – should you invest in tobacco? By Richard Hunter, Head of UK Equities, Hargreaves Lansdown July 11 2006, Businessweek VIDEO "Investing in Tobacco Stocks: How to play it" and a real pearler from "Investment U" pitching why one should invest in tobacco despite the liability and regulation issues Tobacco Stocks: “Smoking” Out Investment Profits From A Blue Chip Titan November 2006. As you ponder what to invest your money in, enjoy some of the wry humour in Thank You for Smoking [2004]. And try not to grin at the catchphrase "Nick Naylor doesn't lie, he filters the truth"..!

The investment case is a lot closer to the ethical case than people think. If one invests, like Warren Buffett, in the firm for its business and long term prospects, how may one look past the product and its effects? Why invest in a sector or firm in a sector where the sector has a large negative exposure? Back in 1997 a public health professor at the top-tier University of Michigan in the USA pushed for major institutional investor TIAA-CREF to back away from tobacco "Vote on TIAA-CREF tobacco investment policy". Also at universities, activist students are a big headache for tobacco industry, being business types, future leaders, and able to see through pseudo-sophisticated arguments, illustrated by the 2004 article on Edinburgh students "Students stub out tobacco investment". A 2007 paper illustrated the irony for Australian pension funds in "Australian pension funds and tobacco investments: promoting ill health and out-of-step with their members", opening with some solid paragraphs:

Calls for institutional investors to divest tobacco shareholdings threaten the industry's share values, publicize its bad behaviour and label it as a politically unacceptable ally (Wander and Malone, 2006). In 1990, US tobacco control advocates began urging government investment and pension funds to divest tobacco stocks as a matter of responsible social policy (Wander and Malone, 2006). Tobacco companies fought hard to counter the divestment push and eventually only seven US states divested their tobacco stocks (Wander and Malone, 2006).

Since 2000, transnational tobacco companies have sought to regain the public's respect and investor confidence by embracing the principle of ‘corporate social responsibility (CSR)’ (Hirschhorn, 2004). The appearance of British American Tobacco in eighth place on a Corporate Responsibility Index for 2006 published by the St James Ethics Centre suggests the CSR strategy has been at least partially successful (Chapman, 2006). Investment analysts continue to describe tobacco shares as a good buy (Dubose Tomassi, 2006). Incredibly, as late as 2004, five leading US medical schools held shares in the tobacco industry (Wander and Malone, 2004). The scope of current pension fund investments in the tobacco industry is indicated by a 2006 estimate that smoke-free legislation in England could add up to £20 billion (US $35 billion) to UK pension deficits (Simpson, 2006).

The irony of seeing nurses smoking by the hospital exit is analogous to the news in June 2009 from Canada that health insurer investment arms are investing in tobacco, which the tobacco industry proudly reported and were defended by the Candian Finance Minister as reported by CBC in June 2009. It appears Nigeria has banned future investment in tobacco. Personal habits are sometimes at odds with the societal good, or even one's personal good.

Ben's column title "Contingent Liabilities Take Shine of BAT" in Business Day 16 July 2009 offers a gentler version of the danger. As he summarizes in his conclusion:

Before you are tempted to buy the shares, however, read [this is always a smart thing for investors to do!] the nine pages on contingent liabilities and financial commitments in Note 30 of the 2008 annual financial accounts [statements]. It is a terrifying horror story, and its possible financial implications on future earnings are not quantified.

Any investor must assess the opportunities for risk and reward from placing money in the ownership or lending of a going concern today, expecting to earn a higher rate of return than some base rate - say the rate of inflation or interest on a cash account. So any investor in a tobacco firm must take a view on the cash returns to the firm in the forthcoming period, or the market's opinion about that return, depending on whether they are basing on fundamentals or relative measures and technical market movements [if you're a trader, it's a matter of seconds, if you're a deep value investors, a matter of years]. That means assessing all the scenarios for the firm. Which include the huge public healthcare costs that are attached say, in the US. Part of the Bloomberg Initiative's purpose to fight tobacco in low and middle-income countries (focusing on 15 countries) is exactly to avoid the future healthcare burden in countries that cannot afford it, literally. The future "settlements" from the tobacco industry of course have created the conundrum where the state government has a vested interest in the tobacco firm thriving and earning cash returns, in order that the tobacco firm pays the settlement into the future. Federal and state legislators have a vested interest in keeping tobacco in business. These are the so-called "Tobacco Bonds", applied and rated by Moodys at state level. Government has a vested interest in cigarettes because of the large excise duties and taxes levied on them, effectively creating a chunk of reliable cash revenues that are hard for politicians to become un-addicted to [see The Red tape Chronicles spotlighting the taxpayers interest in smoking teenagers and made of US state securitization of tobacco settlements in "Ten years Later Tobacco Deal Going Up in Smoke from Nov 2008]. New York state Public Interest Research group [NYPIRG], one of the publicly funded think tanks, outlines the case for state-level divestment in the US [Tobacco Divestment in New York State] in fighting against NY funds invested still in tobacco. Many of these arguments apply in emerging and frontier markets like Brazil, Bangladesh, Malaysia, Sri Lanka or South Africa, which is why the Bloomberg Initiative targets such countries. NYCERS, the activist pension fund active in sustainability and ESG investment, remains invested despite stopping new investment some years ago. We have no view on the efficacy of the "black box warnings" that tobacco companies must slap onto the packaging. Pharmaceutical companies detest that stigma, and food companies have wriggled at the prospect that some of their marginally nutritious foodstuff could deserve the same. Some of the drive to capture the full costs of tobacco is reflected in the litigation and the global regulations to prevent marketing and sale [cigarettes are sold, not bought] that the World Health Organization Tobacco Free Initiative helped drive in the late 1990s under Gro Harlem Brundtland, the former head of the UN sustainable development commission that coined the sustainability definition in 1987:

"Sustainable development is development that meets the needs of the present without compromising the ability of future generations to meet their own needs. It contains within it two key concepts:

1. the concept of 'needs', in particular the essential needs of the world's poor, to which overriding priority should be given; and
2. the idea of limitations imposed by the state of technology and social organization on the environment's ability to meet present and future needs."

It is hard to reconcile this thinking with investment decisions channeling cash today into tobacco, yes? Sustainable finance is about comprehensively assessing explicit and implicit risks and benefits of investments: not just the ones that firms choose to write about, legislators bother to regulate, and lawyers cannot slide past. The investment case is a lot closer to the ethical case than people think. Integrating ESG factors - what is the total lifetime lifecycle cost of tobacco production and sales to humans? - is part of the holistic investment playing field with no externalities that we think all investors should play on. No costs should pushed onto society, and hidden costs should be exposed. Once all the costs and benefits, risks and returns are fully priced in, go ahead, puff away: thank you for smoking.

Rates of Return

Portfolios have now locked in the performance numbers for 2008. Funds were just wrapping up a little window-dressing of holdings at year end, re-balancing before illiquidity forces funds to hold tight, and watching for any bad news from around the world. Portfolio managers around the world will look back glumly at the hammering most portfolios took in the second half of 2008, and look forward to 2009 with gritted teeth. The major indexes flip through the story: S&P 500, Wilshire 5000, Dax, KOSPI, NIKKEI, ALSI 40, FTSE100, BOVESPA, DJSI Global. Only Tunisia was up [10%] for the year – nice work from North Africa! See Reuters FACTBOX-Final major global market losses and gains for 2008

Forecasts trend to the negative, including some that leave one cold, like today’s Factories hit by worst slump in 28 years. Moneyweb’s dry humour delivered the understatement of the year: JSE vs world markets in 2008 - It doesn't look pretty [!]. Large cap growth index tracker Vanguard FTSE Social Index Inv (MUTF:VFTSX)was down in the mid $0% range. One of my favourite small-cap growth equity mutual funds run from Boston by Mat Patsky, Winslow Green Growth(MUTF:WGGFX), was hit 62% for the year. The glass half-full: well, unlike another great fund, at least it is still standing in 2009… See Matt's comments on green investing from Feb when he was ooking forward to poitive net inflows. "When this bear market ends, be prepared for a fast and furious partial recovery," S&P's chief investment strategist Sam Stovall writes in his 2009 outlook. Historically, the S&P 500 has recouped, on average, 33% of its bear market losses 40 days after a bottom.

But at last the annus horribilis for money managers around the world has ended. Being one comfortable as an outlier, I am happy to see the glass half-full, but making the right bets and managing the volatility will be harder.

In Africa’s money management capital, Cape Town [CPT], New Year’s Day 2009 was sunshiny and blue-skied, and well-celebrated as usual, as the NYT reported. The beaches were full, and the Table Mountain cableway had a 600m queue of patient tourists mostly pale, but grilling nicely in the full African sun. You could hear the sizzling. Spreadsheets covered in red have mercifully been archived with just the year-end report backs to pension fund trustees and financial advisors to come before 2008 can be boxed as “the year of the market meltdown”. The pendulum will no doubt swing to over-regulation, and we may look forward to the finesse of the sledgehammer of politicians trying to predict and protect market players from themselves, at least until the next crisis resulting from too much regulation.

The summer weather at the bottom end of Africa and the usual European-style year-end shutdown of the holiday season eases the pressure and keeps one sane. In CPT the type-A investment professionals will be out early or late, on MTB trails in Tokai, running Table Mountain [I bumped into the CEO of Investec Asset Management, one of the big four, the other day]. Water options include wind- or kite-surfing on Sunset or surfskiing from Three Anchor Bay. As one money manager in San Francisco [CPT’s American twin city] commented, at least an hour of exercise per day is necessary to blow off the pressure of needing to be right with major decisions every working day. The major national business dailies' [Business Report and Business Day, as well as FT distribution] print editions are closed through Wed 7 Jan as a reflection of how things slow down. Just the web and the informed few in conversation in business class on aeroplanes or in Plettenburg Bay and similar holidy spots keep the pulse of business conversation throbbing. The success of the SA cricket team in Australia, up 2-0 in the 3 Test series and winning in Australia for the first time has lifted the mood many. A miracle comeback in Perth and a beyond miracle comeback in Melbourne have written the players as legends. If only more people were at their workstations so we could remind our Australian colleagues of the arrogance the past 13 years or so… The final test in Sydney offers the chance to go no.1 in ICB rankings.

Hugh Wheelan put out a thoughtful piece in Responsible-Investor.com just before Christmas, reflecting some of the conversations we have been having about the impact of the meltdown and ESG investment research as ongoing concern and business unit [see What’s the future for ESG broker research? SRI team cuts and the merger of EAI and PRI demand clear future research incentives by Hugh Wheelan, December 22nd, 2008] “a worrying development for those concerned that ESG research, still a relatively new and growing discipline, could become ‘mainstreamed’ for cost rather than content reasons”. Ironically, the cuts at Deutsche Bank ESG research in London have come as calls for more corporate governance research has flooded in.

I expect more testing of where the sustainability meta-theme intersects with “business as usual” in 2009. My philosophy that sustainability is a meta-theme, over-arching and impacting all facets of economic life on this planet, implies I am less perturbed by the coming or going of specific business units with “sustainability” tags. Like many others, my BS filter often blinks red when talking with so-called experts in sustainability, or some initiatives, or companies spinning the same old stuff through the “greenwashing” cycle [see Corpwatch's bimonthly greenwash awards]. A comment in an excellent Fast Company article from “artiste” architect Steven Holl rings true in my work as an investment architect. Some of the sustainability stuff is ugly!

One facet of his work that he actually downplays, however, is his interest in sustainable architecture. "I'm sorry to say, but 85% of so-called green firms make some of the ugliest buildings that were ever made," he says, in a typical excess of candor. "So for God's sake, I don't want to be categorized with them."

It is hard to put a value on a life, but the ROR for one woman’s life is high. The biggest news in the city was the passing of a political legend in SA, Helen Suzman. Ms Suzman was renowned for many years in the whites-only SA parliament as the sole representative of the opposition Liberal Party standing up to the National Party and the apartheid machine from 1961-1973, at least from the inside. The fact that she was female, English-speaking and Jewish must have caused endless indigestion for chauvinistic Afrikaners dreaming of a great white nation. In one of those ironies, in seeking to break down racial barriers Ms Suzman represented Houghton, an elite enclave in Johannesburg’s leafy suburbs, not far from where I enjoyed some years in the mid-1990’s, and an excellent fitness center at Old Eds. I never had the pleasure of meeting her, but her lifetime journey and steadfast integrity to her cause remains a remarkable life lived well. 91 good years. Beyond her signal achievements in life, two parallels to the conceptual and contextual work in sustainability + investment come to mind: firstly, the dogged nature required moving forward with the expectation of being a lonely traveler on the journey, and secondly, respect of her rivals. Her former opponents were forthright in their praise in media coverage, although maybe all of them mellow with age, knowing their fight are now decades old, and as older people, they are more collegial than competitive. Major South Africans have been forthright in their praise, and fittingly the icon on democratic South Africa offers the simplest and best admonition: Nelson Mandela described her as “a remarkable South African woman”. South African flags will fly at half-mast on Sunday January 4th 2009 in honour of anti-apartheid veteran Helen Suzman.