Would you invest in companies whose product kills seven million people every year, costs society $2 trillion annually in medical expenses, uses child labour in the production of its product, is blacklisted as an investment by governments that are signatories to an international tobacco treaty and whose future profitability faces material legislative, regulatory, and litigation risks? If the answer is no, your fund should have zero exposure to tobacco stocks.
Why have I and people like the chief executive officer of the AXA Group come to believe that? Because radiation oncologist Dr. Bronwyn King has confronted both of us with the realities of “the profound death and disease” tobacco has caused and will continue to inflict on hundreds of millions of people around the world. She has told a powerful personal story of working hard to diagnose and treat people with lung cancer and then discovering, to her horror, that through her Australian superannuation fund, she was an investor in tobacco companies.
The realization led her to create Tobacco Free Portfolios, a not-for-profit organization that has been taking its message to the world’s institutional investment community and with growing impact.
The goal of this letter is to persuade organizations to seriously consider the merits of the message about zero tobacco exposure. I do so by setting out the ethical and financial cases against tobacco investments in some detail and documenting the growing acceptance of Tobacco Free Portfolios’ position by institutional investors around the world.
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The heart of the ethical case against tobacco is reflected in Dr. Bronwyn King’s reaction to finding out that she had a direct financial interest in companies that are a major cause of the despair and suffering she witnessed in her day job as a radiation oncologist. As she correctly pointed out, by investing in tobacco, investors are effectively endorsing a product that is the No. 1 cause of preventable deaths in the world (even today, the five-year lung cancer survival rate is only 15 per cent), has no social merit (most smokers would quit if they could), causes widespread suffering and has been blacklisted as an investment by the United Nations’ tobacco treaty. Tobacco consumption has a negative impact on 13 of the United Nations’ 17 sustainable development goals, including those related to eradicating poverty, biodiversity losses, pollution, birth complications, food insecurity and illicit trade.
Especially insidious is the industry’s use of child labour in harvesting tobacco leaves. In March 2017, the International Labor Organization issued a report stating that “in tobacco-growing communities, child labour is rampant.” Many of those children develop green tobacco sickness (nausea, vomiting, dizziness and headaches) and face unacceptable working conditions (long hours, too little water, poor sanitation, inadequate training and lack of legal protection). At the same time, the children are a primary customer target for the product. An estimated one in five Indonesian children under the age of 10 are smokers.
Please take a moment to imagine a front-page headline announcing your fund is an investor in organizations involved in all of that. In my view, it adds up to considerable reputational risk for your fund. And in this case, constructive engagement is not an option, as the only acceptable tangible outcome is for tobacco companies to exit their primary business.
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The financial case against tobacco stocks cannot be based on their historical investment performance. For example, over the 2005-15 period, the MSCI world tobacco index was up 195 per cent (versus 90 per cent for the information industry index and 50 per cent for the total index). Many analysts continue to recommend investment in tobacco stocks despite steadily falling sales volumes. Buy ratings are based on such considerations as generous dividend yields in the range of three to six per cent, a steady diet of share buybacks and, at least so far, the industry’s ability to raise prices enough to offset falling sales volumes.
So what is the financial case against tobacco? There are in fact two cases: one based on litigation risk and the other on legislative and regulatory factors. The former proceeds from the legal argument that tobacco companies sell an addictive product connected to an extended list of medical consequences that lead to loading material costs on health-care systems around the world. The tobacco industry should fully compensate victims and health systems for the resulting human and financial consequences. The latter case is based on the recognition that the human and financial consequences of nicotine addiction demand international and national public policy responses to contain and reduce the demand for tobacco products.
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Litigation risk: The tobacco industry has a long history of facing class action suits. Just in the United States, the current number of live product liability cases is estimated to be about 6,000. However, it is Canada that may be taking legal action against the tobacco industry to a new level. It started with a $27-billion class action suit involving a million Quebec smokers launched in 1999. The case finally went to court in 2012, leading to a 2015 $15-billion decision for the plaintiffs. Ontario took a different route, first passing legislation in 2009 allowing it to recover the cost of treating smoking-related medical expenses. With the legislation in place, it sued the tobacco industry for $50 billion, based on tobacco-related medical cost recovery, going back to 1955. The suit asserts the tobacco industry knows nicotine to be addictive, knows it to cause cancer, has failed to properly warn users of these risks, has suppressed evidence, has destroyed documents, and has engaged in unscrupulous marketing practices.
Similar legal actions by other Canadian provinces are also winding their way through the courts. New Brunswick has a November 2019 court date. There is no court date yet for the Ontario case, but it is expected soon. Findings for the plaintiffs would open the door to similar successes for the other provinces and, indeed, for other governments around the world. It would not take a lot of $50-billion legal victories to wipe out the profits of the entire tobacco industry for years to come. Finally, interesting new legal channels are opening up. Just this past May, the Dutch launched a criminal action against the tobacco industry, charging it with fraud and aggravated assault. Also, in assessing legal liability for damages and costs, Brazil’s Superior Court of Justice recently noted that in addition to those directly responsible, liability may also extend to those “who benefit from what others do.”
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Legislative/regulatory risk: With the signatures of 181 countries with 90 per cent of the globe’s population, the United Nations’ tobacco treaty has more support than any other UN agreement. The treaty, and the parallel World Health Organization framework convention on tobacco control, represent an unprecedented degree of international co-operation to reduce the use of tobacco products in both the developed and the developing worlds. A noteworthy clause requires government agencies (including pension and sovereign wealth funds) not to invest in the tobacco industry.
Meanwhile, similar control efforts (such as excise taxes and packaging restrictions) continue to build at the national level. A recent initiative by the U.S. Federal Drug Administration is especially noteworthy. In a July 28 press release, the FDA announced “a new comprehensive plan for tobacco and nicotine regulation . . . placing addiction at the centre . . . by lowering nicotine content to non-addictive levels through achievable product standards.” Financial markets reacted immediately to the new threat to the tobacco industry’s long-term viability. Tobacco stock prices declined by five to 10 per cent on the news, for a collective loss of $26 billion. They have yet to recover these losses.
So what does all this mean for institutional investing in general and for the investment policies of pension organizations in particular?
Implications for investment policy
People managing other people’s money have a fiduciary obligation to ensure the investment decisions they make (or are made on their behalf) pass tests related to reasonable ethics and no undue risks. I have come to the view that tobacco investments fail both tests.
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Tobacco investments are not ethical in the sense that investing in them signals giving safe harbour to a product known to be the No. 1 cause of preventable deaths in the world; have a negative impact on 13 of the UN’s 17 sustainable development goals; and make significant use of child labour in the harvesting of sickness-producing tobacco leaves.
Tobacco investments carry undue reputational risk if these ethical issues are left unaddressed.
Tobacco investments carry undue financial risk in exposing investors to a continuously increasing volume of legislative, regulatory and litigation actions. The former actions have a negative impact on the industry’s revenues, the latter on its costs of doing business. Taken together, they lead to a plausible continuous squeeze on the tobacco industry’s future profitability. All of this leads to material stranded-asset risk down the road.
I am not alone in this view. A recent investor statement on tobacco in support of tobacco control measures has already garnered 53 signatories with a collective $4 trillion under management. As an example, when asked about its tobacco divestment decision, here is how the New Zealand Superannuation Fund explained its 2007 decision from a ‘responsible investor’ perspective:
As a product, tobacco fails product safety and ethics tests.
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The tobacco industry is a poor prospect for effective investor engagement.
Tobacco investment has no material impact on the fund’s reward/risk characteristics.
Investment would be inconsistent with the UN tobacco treaty and the WHO framework convention on tobacco control. Thus, investing in tobacco would damage New Zealand’s reputation in the world community as a responsible investor. The New Zealand fund notes that over time, its 2007 divestment decision has garnered broad support from its stakeholders.
Your organization’s next step
If, like the New Zealand fund and many others, your organization is already tobacco-free, take a moment to celebrate the progressive decision already taken. Also, ask if the tobacco-free fact and its rationale have been clearly communicated to your organization’s stakeholders.
If, on the other hand, your organization is not yet tobacco-free, take a moment to ask why not. Possibly, it is because no one to date has placed the tobacco-free action item on the organizational decision agenda. After all, the manufacture and sale of cigarettes is not illegal, and investment returns have been good. Further, making investment decisions with ethical connotations can be awkward.
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It is my hope that this letter will trigger the appearance of tobacco investing on your organization’s decision agenda soon. The case for divestment is growing stronger year by year.
Keith Ambachtsheer is director emeritus of the Rotman International Centre for Pension Management.