One of the world’s largest pension investors might soon reverse a long-standing decision to divest tobacco. Should it re-engage with the industry, simply in a pursuit of profit, asks Jonathan Williams

One of the world’s largest pension funds, the California Public Employees’ Retirement System (CalPERS), may soon reverse a 15-year-old decision to divest tobacco after research showed it had foregone $3bn (€2.6bn) in returns.

The $293bn fund’s investment committee on 19 April signed off on a two-year study into the re-admission of 22 tobacco stocks, allowing it to canvass its stakeholders over the change in strategy.

In papers prepared for the committee, CalPERS admitted that the question of whether to invest or divest various sectors, including tobacco, had become a “difficult and complex issue”.

It also expressed a preference for shareholder engagement over divestment, noting that dialogue should be “the first call to action and the most constructive form of communicating concerns”, an ethos that would potentially pave the way for a re-admittance of the tobacco stocks following a two-year study.

According to a paper by its consultants Wilshire Associates, its exposure to stocks would account for around $1bn of its $156bn global equity portfolio.

The same study also estimates that CalPERS has lost at most $3bn from its divestment decision, and that its continued divestment would lead to a portfolio discrepancy of $172m during one out of every 20 years.

Despite the returns foregone, and seeing engagement as preferential to selling stakes, the fund’s revised investment policy still allows for divestment of individual firms, even where it clearly views such sales as problematic.

It notes, for example, that, in some instances, the fund’s fiduciary duty might allow a ban on acquiring any greater stake in a firm but not its complete sale.

Divesting certain industries or companies has shifted back into the limelight in recent months, as pension and other institutional investors push ahead with bans on high-carbon companies, such as utilities and certain mining firms.

Risk versus returns

CalPERS is likely to view the sale of coal holdings as a more cut-and-dried situation, and the fund is indeed among numerous investors to have sold out of thermal coal over the last year after the Californian government passed a law banning coal holdings for CalPERS and the California State Teachers’ Retirement System.

However, the sale of coal holdings can easily be viewed as reducing risk, without sacrificing returns, two areas highlighted by CalPERS in its policy on divestment.

As Danish provider PKA shows, its decision to sell stakes in select coal companies saved it from exposure to a 70% decline in their share price.

The provider is expanding its engagement progamme with companies drawing revenues from coal and says it will divest those that fail to put in place a policy that reduces reliance on the asset.

The tobacco industry – unlike the coal industry, faced with a global consensus to lower carbon emissions that casts doubt on long-term profitability – still enjoys profits despite attempts by governments the world over to reduce smoking. If CalPERS continues to shun the sector, it is likely to continue to forego returns needed to pay pensions.

But CalPERS is by far not the only fund to divest tobacco. The Dutch pension manager PGGM, which largely manages money for healthcare sector fund PFZW, no longer invests in the industry, citing companies’ reluctance to engage on concerns around child labour and marketing targeted at young people but also the “problematic” relationship smoking enjoys with its membership in the healthcare sector.

Norway’s Government Pension Fund Global has also excluded some of the largest tobacco manufacturers, including Philip Morris, since 2009.

Local government pension schemes (LGPS) in the UK were advised in 2014 that they could divest tobacco on the grounds of its health impact. But they faced a problem similar to the one facing CalPERS, loath to deny their membership returns, even where local authorities were now directly responsible for healthcare.

“The [LGPS] administering authority’s power of investment must be exercised for investment purposes and not for any wider purposes,” an opinion by Nigel Giffin QC, prepared for the then-shadow LGPS Advisory Board concluded. “Investment decisions must therefore be directed towards achieving a wide variety of suitable investments, and to what is best for the financial position of the fund (balancing risk and return in the normal way).”

Unlike exclusions based on the grounds of carbon footprint, the exclusion of tobacco companies is a trickier issue when examined through the prism of profit. But investors should question whether any companies – if excluded solely for health reasons, for producing unhealthy goods – should be admitted, and perhaps consider, for example, a health-based sin-stock exclusion. That or companies must be called out for other ethical breaches, such as the concerns around employment cited by PGGM for its exclusion.

Alternatively, funds must canvass their members for their opinions on tobacco and see whether they wish to exclude it, regardless of the potential cost.