Institutional money managers can't seem to kick the tobacco habit, despite the barrage of negative news that has sent the stocks into a tailspin.
But public funds might be forced to quit. Resolutions calling for funds to divest of tobacco stocks are on the rise. The keenest pressure is on the public funds of the 14 states whose attorneys general are suing tobacco companies to recover Medicaid's medical costs of smokers.
In addition to political pressures, pension executives are torn between their fiduciary duty to hold tobacco stocks - which have been strong performers until recently - and the looming litigation risk to tobacco companies.
Money managers, by contrast, say they would buy more tobacco stocks, particularly Philip Morris Cos. Inc., if they didn't have such large positions already. They cite tobacco companies' earnings growth, dividends and the potential for spinoffs of non-tobacco businesses. They believe there's little downside at current prices, and state Medicaid cases are unfair.
Mutual fund managers in particular are hooked on the rich dividends of Philip Morris, the largest holding of stock funds, according to Lipper Analytical Services, Summit, N.J. In fact, on Aug. 28 the company raised its dividend to $4.80 a share for a yield of 5.2%, compared with only 2.2% for the Standard & Poor's 500 Stock Index.
"We like the dividends, the management and the cash flow-generating ability (of Philip Morris)," said Nancy Crouse, vice president of Delaware Management Co., Philadelphia, which added to its position on weakness.
'Trying not to inhale'
While money managers are high on tobacco stocks, public pension funds are trying not to inhale.
The New York City Employees' Retirement System, for example, has formed a six-member trustee committee to focus on the tobacco dilemma. The group has asked the fund's retainer consultant, Callan Associates, to analyze the performance of tobacco stocks.
"The irony of this whole thing: RJR and Philip Morris (until) a few weeks ago were trading near their highs. Between July 31, 1995, and July 31, 1996, the tobacco group was up 40.94%," said Martin Rosenblatt, assistant deputy advocate for research and investigation. He represents Public Advocate Mark Green on the NYCERS board and is on the trustees' tobacco committee.
"A fiduciary is confronted with high yields and growth" of tobacco stocks, coupled with "the increasing sale of cigarettes overseas to compensate for a decline in sales here. Do we hold, not hold, restrict, not buy anymore? We may or may not hire attorneys to help in the analysis.
"It's unlikely but a member could sue us for selling a high-performing stock," Mr. Rosenblatt said. "There's even a possibility NYCERS could be sued by the tobacco companies if it dumps the stocks and depresses prices by triggering sales by other municipalities," he said.
Andrew Olma, investment strategist at BZW Barclays Global Investors, San Francisco, which runs $100 billion in S&P 500 index funds, said: "Most plan sponsors are looking for future guidance from legislators in this area. I've heard from three pension funds who discussed (a tobacco-less index) with us at great length and might do it before year end; another half dozen to 10 have discussed it on a more casual basis."
Divestiture still an issue
While no state fund has divested yet, according to the Council of Institutional Investors, Washington, the cities of Cambridge, Mass., and Pittsburgh approved laws requiring the divestment of tobacco holdings. Similar resolutions are pending in Chicago and Los Angeles.
Massachusetts state Rep. John Businger might reintroduce a divestment bill in the next legislative session. Also, a bill was introduced in Illinois to freeze any new tobacco investments. Louisiana and Michigan might introduce similar bills. California Assemblyman Wally Knox sponsored a bill that would require the state's pension funds to stop investing in tobacco companies and divest their holdings within three years, according to the council.
But a spokesman for the California Public Employees' Retirement System said: "The risks of tobacco litigation are already embedded in the abnormally low tobacco stock (price-earnings) ratios. We're not going to be divesting. It would significantly reduce the universe of securities we're already invested in."
Managers have a similar view.
"You'll never know what will happen, particularly when cases go to a jury, so we wouldn't have 10% in tobacco. But when the risk is more than discounted in the stock price, we're willing to step up and buy the stock," Delaware's Ms. Crouse said. Philip Morris "is selling at a 40% discount to the S&P (price-earnings ratio). .... It's as low as it's been in the last 20 years," she said.
Delaware, which has $14.5 billion in value equities, has owned Philip Morris fairly steadily for the past 21/2 years. Delaware's stake in RJR Nabisco Inc. is half the size of its Philip Morris stake even though the stock looks cheaper on a price-to-cash-flow basis and has a 7% dividend on its common stock.
"We're not as confident in the fundamentals (of RJR). Philip Morris is better capitalized with stronger businesses, a larger international business and a larger food company," Ms. Crouse said
Michael Price sold Philip Morris
Michael Price, president of the $17 billion Mutual Series Fund of Heine Securities Corp., Short Hills, N.J., sold his hefty Philip Morris stake in the past two months, but still holds RJR. His RJR Nabisco stake was sharply cut back to less than 1% of the portfolio. RJR remains a holding because he thinks it has a higher probability than Philip Morris of spinning off its food business.
He also still likes the U.K.'s B.A.T. Industries PLC because more than half of its businesses are financial.
Federated Investors, Pittsburgh, sold its RJR holdings some time ago but still owns Philip Morris and Loews Corp., which is mainly an insurance company, in the Federated Stock Trust and American Leaders funds, which have $2 billion, according to Peter R. Anderson, senior vice president and co-portfolio manager.
Art Cecil, a research analyst at T. Rowe Price Associates Inc., Baltimore, said: "My longer term view hasn't changed. The industry isn't going to be financially crippled by lawyers, but there will be short-term setbacks and they'll have to deal with it."
'Iron stomach' necessary
As an investor, "you have to have an iron stomach or a tight safe deposit box," Mr. Cecil said.
He thinks Medicaid-related cases are without merit. "I think it's all BS. Why are cigarette companies being singled out? Why not go after alcohol or automobile companies?"
T. Rowe Price's top tobacco holding is Philip Morris, but it also owns UST Inc. and RJR.
Tobacco-less index funds suffer
At BZW Barclays, which runs $100 billion in S&P 500 index funds, the funds holding tobacco stocks have done 17 basis points better on average per year since 1980 than non-tobacco funds.
"What we've found is if you go back to 1980 through the end of the second quarter, (divesting) hurt returns - by 17 basis points a year on average. It really depends on how Philip Morris does."
"Seventeen basis points is not a huge difference to an active manager, but in indexing clients ask us to analyze performance down to the basis point or sub-basis point level. Seventeen basis points is $170,000 of $1 billion, so for a $10 billion pension fund that's $1.7 million in lost return," albeit historical return, Mr. Olma said.