By Mark Fairbairn, CFA, B.Eng.
Senior Investment Analyst, International Equities
Would you be alarmed if your retirement fund was hooked on cigarettes?
I recently met Dr. Bronwyn King, a practising radiation oncologist from Australia and founder of Tobacco Free Portfolios, a non-profit group that aims to eliminate pension fund investments in tobacco.
In 2010, Dr. King was dismayed to find out she profited from the very products responsible for her patients’ life-threatening illnesses. Like other Australian health professionals, she owned tobacco company stocks inadvertently through her workplace pension fund.
Dr. King learned the largest foreign holding in her portfolio at the time was British American Tobacco. Convinced there is no safe level of consumption of tobacco, she began to engage the financial sector with economic reasons to butt out.
Since then, Tobacco Free Portfolios has seen 35 Australian pension funds (called superannuation funds) implement tobacco-free investment mandates, and a major insurer, AXA, divest tobacco industry assets valued at €1.8 billion (approximately C$2.5 billion).
No smoking in our portfolios, please!
To us, Dr. King doesn’t sound at all radical: MD has restricted tobacco-related investments since 1969.
Every proprietary MD investment product is free of direct exposure to tobacco securities. We don’t buy individual securities (bonds, equities or derivatives) issued by companies involved in the manufacturing of tobacco or tobacco-related products.
We actively screen out all tobacco producers, eliminating names such as Philip Morris, Altria or British American Tobacco. Even our index funds are tobacco-free.
CMA advocacy guides investments
Working toward a smoke-free Canada, the Canadian Medical Association (CMA) issued its first public warning about the hazards of tobacco in 1954.
Since 2004, the CMA has urged the Canada Pension Plan Investment Board to divest tobacco holdings. (For the record, it hasn’t).
More recently, with the emergence of cannabis companies on Canadian and international stock exchanges, CMA passed a motion to extend MD investment restrictions to screen out companies that manufacture marijuana or marijuana-related products.
As with tobacco, that move reflects the association’s longstanding concerns about health risks associated with consuming marijuana, and its belief that there has been insufficient scientific research or clinical assessment to provide definitive guidance on the use of medicinal marijuana.
Smoking out the numbers: the lure of tobacco
Some investors just won’t quit tobacco stocks that have reaped huge returns over 20 years.
As an industry seen to be on the outs, stocks were historically priced low, paid big dividends and have been less cyclical than the overall market—smokers tend not to quit in a recession.
Stock prices slumped in the wake of the 1998 Tobacco Master Settlement Agreement, in which companies agreed to pay more than US$200 billion to 46 U.S. states over 25 years, then more in perpetuity, to recover tobacco-related healthcare costs.
Since that time, from November 1998 to the end of May 2017, these stocks have been on a burn.
Over that period, annualized return in U.S. dollar terms, for the tobacco industry in the U.S. Russell 1000 Index was 15.7% compared to 6.6% for the overall broad index.1 Globally, the MSCI World Index tobacco sub-industry returned an annualized 13.4% in U.S. dollar terms over the same period—compared to the 5.5% annualized return of the broad MSCI World.2
We like to think of the ashtray as half empty
If you’d invested in nothing other than tobacco 20 years ago, yes, you’d be richer—but no prudent portfolio would ever be concentrated in one industry.
Tobacco stocks have performed superbly, but comprise less than 2% of the markets; their absence won’t materially impact broader portfolios. As active managers, we see lots of opportunities in the other 98% of the universe.
Tobacco stocks are no longer pricing in a “sin” discount, trading at a 20% to 30% premium to the market. Current valuations and risks associated with these businesses make them less attractive. For instance, most provinces have lawsuits in the works to try and recover healthcare costs.
Getting second-hand smoke out of funds
What to invest in instead? As an example, look inside MDPIM International Equity Pool—one of our actively managed investment funds. Its top position currently is a pharmaceutical: Roche.
Compare Roche to British American Tobacco (BAT): It has a similar dividend yield; a lower valuation; and a similarly defensive return profile, in that customers will likely keep taking their meds during recessions.
BAT’s growth depends on expanding use of a product known to be dangerous. For Roche, it’s to develop drugs and therapies to improve health.
That’s a substitute that is easy to chew on.