Are you an institutional investor who takes your role as a fiduciary seriously? If so, a new report just claimed the top spot on your "must read" list. It is "Tobacco's Changing Context," a study from the Social Investment Forum and Co-op America that speaks directly to institutional investors. According to the authors, institutional investors will find themselves under growing pressure in 1997 to reconsider investment policies around tobacco.
If you are inclined to dismiss out of hand the report's core conclusion, you probably labor under one or more of the three most common misapprehensions about tobacco stocks.
Performance
Many institutional investors probably will be startled by the data in the study showing tobacco stocks have experienced erratic performance in recent years.
It used to be that tobacco's strong performance was an excuse invoked by many institutional investors to ignore the strong moral and health arguments against investing in tobacco. In essence, these individuals said: with what tobacco is returning, we can't afford your principles.
But King Tobacco, as it once was called, no longer reigns supreme over the stock market. In fact, the report shows the annualized return of every major American tobacco company fell below that of the Standard & Poor's 500 during the past five years. The report notes several examples of portfolios that have booked superior returns without tobacco, like the Domini Social Index, a tobacco-free index of 400 socially screened companies that regularly has outperformed the S&P 500 and the Russell 1000 since its launch in May 1990.
The tobacco study sends the clear message that the performance-related excuses relied upon by some institutional investors for staying in tobacco stocks are being blown away like cigarette smoke in a stiff breeze. As a fiduciary, you are likely to find yourself asking: given the horrific moral and medical consequences of tobacco use, where's the compelling economic case for investing is tobacco stocks?
ERISA headaches
Since Department of Labor law and regulations apply to the funds you manage or oversee, you might be under the impression that the Employee Retirement Income Security Act forbids you from backing away from tobacco. This is an overly cautious and narrow interpretation.
It is a mistake to assume ERISA speaks directly to tobacco investing. The relevant federal rules in essence simply require institutional investors disregard non-financial information in those cases where investments perform at or above market averages.
Unreliable performance numbers mean tobacco stocks no longer can rely on this defense under ERISA. In fact, when the performance of tobacco stocks is adjusted for risk (volatility) over the past five years, the stocks are clear underachievers.
Further, it is important to put things in perspective: Tobacco manufacturing companies represent only about 2.4% of the S&P 500's market capitalization. This is a tiny fraction of the overall market, particularly when compared with the nearly 40% of S&P 500 companies that were once off-limits to those institutional investors that avoided the stocks of companies associated with South Africa.
Resiliency of the industry
The third and final major misapprehension about tobacco stocks has to do with the seemingly miraculous ability of the tobacco industry to dodge most any bullet that comes its way. That might have been true at one time, but the tobacco study clearly shows how the overall fortunes of the tobacco industry took a sharp downturn in 1996.
Ethical, legal and economic pressures confronting the tobacco industry rose steadily throughout 1996, according to the new report. In April, the American Medical Association called upon all concerned Americans to divest of their tobacco stocks and bonds. Managers of three major state public pension funds took steps to reduce their exposure to tobacco stock. At least 47 tobacco-related shareholder resolutions were proposed in 1996, up sharply from 37 in 1995 and just 15 in 1994.
In August, an executive order signed by President Clinton permitted the Food and Drug Administration to curb tobacco advertising and promotion to children. By November, 16 states had queued up in court rooms across the nation to recover tobacco-related medical costs that otherwise would be shouldered by taxpayers. In what might end up being a devastating long-term blow to the industry, medical experts came forward in an October 1996 Journal of Science article with the long-sought "missing link," a direct causal relationship between smoking and lung cancer.
Just as important as the facts about the decline of tobacco is the new report's walk-through of the key issues involved in developing a tobacco screen for investment purposes, the legal and economic implications of divestment, and how to mount anti-tobacco shareholder resolutions. In addition, the report explores alternative strategies, such as reducing tobacco ownership, freezing tobacco holdings at current levels, and engaging in shareholder activism.
Co-op America Executive Director Alisa Gravitz explains it this way: "Today, it's almost impossible to ignore the inexorable forces that are converging in such a way that prudent institutional investors will have no choice as fiduciaries but to consider kicking the tobacco habit in 1997."
Is this really such a radical idea any more? Mainstream American investors don't think so. In a Yankelovich Partners survey commissioned by Calvert Group, 59% of investors surveyed (corresponding to more than 27 million people) would prefer to invest in a tobacco-free mutual fund. There is near universal revulsion today at the notion of any sort of association with an industry linked on an annual basis to 400,000 American deaths and the enslavement through nicotine addiction of 1 million of our children.
For institutional investors, the plain, clearly understood facts should guide their conduct as fiduciaries. When you strip away the most common misapprehensions, King Tobacco looks an awful lot like the emperor with no clothes.
Steve Schueth is vice president of Calvert Group, a Bethesda, Md., mutual fund firm, and president of the Social Investment Forum. "Tobacco's Changing Context" is available for $59 from the Social Investment Forum by calling (202) 872-5319. You can also read the report on the Internet at http: www.socialinvest.org
