The wages of investing in sin
Even in a recession, tobacco companies have proved to be extremely profitable; avoiding so-called sin investments is harder than it seems, reports Jason Krupp.
Ask the average person if they'd invest their hard- earned money in a law-suit-prone industry that makes addictive, cancer- causing products and the answer would almost predictably be "No".
But what if these companies delivered a near- 60 per cent return during the worst recession in 80 years, outpacing almost every other stock benchmark in the process. Still think the answer would be "No"?
This is no mere hypothetical scenario. Since the collapse of Lehman Bothers in September 2008, the Dow Jones Tobacco Index has delivered a return of 56.3 per cent. Over the same period, the broader Dow Jones Industrial Average gained 14.6 per cent, the Standard & Poor's rose 9.1 per cent, the NZX 50 rose 5 per cent, and Australia's S&P/ ASX 200 fell 16 per cent.
Thanks to robust sales from popular brands such as Marlboro, Benson & Hedges, Pall Mall, Lucky Strike and Camel, companies such as Phillip Morris and British American Tobacco have proved to be major investment cash cows. However, these profits come with significant social costs.
According to the World Health Organisation's Economics of Tobacco Toolkit, health costs attributed to smoking account for between 6 per cent and 15 per cent of national healthcare expenditure in developed countries.
In Australia, smoking costs equated to between 2.1 per cent and 3.4 per cent of gross domestic product.
New Zealand was not featured in the report but, if the results were comparable here, it would mean Kiwi taxpayers fork out about $7 billion a year to treat smoking-related diseases.
For ethical investors, that's a cost/benefit equation that just doesn't add up, but avoiding so-called sin investments is harder than it seems. That's because the most commonly used investment vehicles for investors to get low-risk exposure to international markets is through exchange-traded funds (ETF) and index trackers. These operate by buying a weighted stake in every single share on an index, meaning an investment in the popular Dow Jones SPDR ETF would ensure a proportional investment in tobacco stocks.
Investing through a managed fund offers more control, with some providers allowing their customers to screen investments based on environmental, social and governance (ESG) lines. However, this, too, is problematic. Though many institutional investors require the companies that they're thinking of investing in to declare their ESG compliance, few police it.
Secondly, under securities law, fund managers don't have to disclose which companies they have invested in as that information is regarded as proprietary. This makes the vetting of a fund's portfolio that much harder.
Further muddying the waters for the socially conscious retail investor is the fact that not all sin stocks are as obvious to spot as big tobacco.
SkyCity Entertainment, the locally listed casino and hotel operator, is an example where ethically guided investors may have concerns over the business it's in. However, some companies are exposed to sin profit on a less obvious level.
"Clearly tobacco companies and casinos are problematic but what about a winemaker such as Delegat's or [brewer] Fosters in Australia?" asks Stuart Hardy, an adviser at Craig Investment Partners.
A bottle of wine may hardly seem like a "sin" at all but it's been responsible for more traffic deaths than a cigarette. Indeed, WHO lists alcohol as the third-biggest risk factor for premature mortality, disability and loss of health globally.
Even if investors aren't active in the market, there is a good chance some of their money is being funnelled into sin stocks through their pension contributions.
Most KiwiSaver funds operate under the same methodology as managed funds, and make extensive use of tracker funds to benchmark their performance.
Notably, the New Zealand Superannuation Fund, a large sovereign investment vehicle that helps fund pensions, drew strong criticism last year for reportedly investing in cigarette and cluster bomb manufacturers, despite having clear ESG guidelines barring these investments. The stocks were held through passive funds, with the "sin products" manufactured by subsidiary companies of the primary investment.
So if the professionals struggle to tell the difference, how is the retail investor expected to?
Craig Brown, senior investment analyst at ANZ's wealth management unit One Path, says his firm's investment profile does not include an ESG filter except in specific cases where a large organisation such as a church would have conflict holding gambling or liquor-related shares.
In fact, Brown considers ESG investing "faddish", saying it works when markets are booming and investors are willing to sacrifice some topside returns on socially conscious grounds but in bear markets, the chase for returns tends to trump ethical considerations.
"If you trawl the market right now, there's not much out there in terms of [ESG] product because there isn't a big demand for it.
"There are not a lot of funds that are strictly managed on that basis."
Given the level of research required and the whopping blow to your potential returns for conscionable investing, it does beg the question whether it's all worth it.
Mint Asset Management portfolio manager Shane Solly concedes that, on ESG grounds, the investment landscape can be so complicated to assess that it may prove too hard to do so for the average investor. Instead he suggests that investors consider offsetting these investments in much the same way as many governments are proposing to do with carbon credit schemes.
"Maybe your fund does have some cash invested in a tobacco company but you could offset this with a donation to [an anti-smoking] charity," he said.
But Craig Stent, a director and research analyst at Harbour Asset Management, says his company's research indicates that a company which improves its governance as well as social and environmental performance will, over time, provide better share price outcomes for investors.
"The initial gains come predominantly from governance improvements, particularly from those companies based in emerging economies, but spread out into environmental and social concerns," he said.
And given that governments are increasingly tightening the noose on sin stocks and polluters, it stands to reason that companies which transform along ESG lines now could well be the winners further down the track. Fairfax NZ