The S&P 500 Tobacco index has out-performed the S&P by more than 1,000% over the last 28 years, creating significant investment returns for investors.
This creates a dilemma for investors' fiduciary duty as some investors may be concerned that smoking-caused diseases could kill as many as 1 billion people worldwide this century. Not only might this undermine economic growth as many smokers die in their most economically productive years, but, the sector is also susceptible to other environmental and social issues such as evidence which suggests that almost no cigarette can be guaranteed to be free from child labour.
Using available evidence, we estimate that the industry creates at least 5 times more societal costs than benefits as measured by investment returns, taxes paid, staff salaries, donations and the U.S. Food and Drug Administration's estimate of potential ‘lost utility' from anti-tobacco regulations. This does not include the controversial ‘benefit' that premature death caused by smoking reduces pension liabilities. However, we were unable to find any data on this ‘benefit'.
Health costs and lost productivity due to premature death and disability make smoking one of the greatest economic burdens on society, rivalling armed violence: 3.0% of global GDP or USD 2.1 tn according to McKinsey Global Institute, World Health Organisation (‘WHO') and literature review studies.
Additionally, this does not include other costs such as the economic opportunity cost of cigarettes. For instance, WHO (2004a) cites evidence from several countries where the addictive nature of tobacco causes poor people in developing countries to spend 2-10x more on cigarettes than on food or education. As well, smokers often have lower day to day productivity; there are also significant environmental and social impacts of tobacco crop production including the prevalence of child labour; cigarette-caused fire/smoke damage, injury and death, which leads to higher insurance costs. Cigarette litter also damages the environment as well as being a costly and unsightly waste for cities to collect.
Due to these negative impacts, and the potential for governments to strengthen regulations in line with the WHO Convention on Tobacco Control, some investors may decide to engage with the industry and governments, and/or divest from the sector entirely. In fact there appears to be a strong parallel between the UN Paris Climate Agreement and the WHO Tobacco Convention: their ultimate goals are supported by the vast majority of countries and both call for a near complete elimination of carbon emissions and tobacco use. In both areas, the question is the rate of change and if companies and investors are adequately assessing risks.
Just as investors have become more concerned with climate change risks, investors with a global and long-term investment horizon may be concerned with how the tobacco industry's cost externalisation affects economic growth and by extension, the financial performance of other assets as well as the likely pace of ongoing government regulation around the world to curb tobacco use.
An increasing number of investors are divesting their tobacco stocks and/or bonds, though this is still small compared to the industry's market capitalisation. Notably, CalPERS decided to expand its tobacco divestment policy to its external managers despite their financial advisors recommending tobacco re-investment. However, the high negative externalities of the industry suggest that investors who are not able to or willing to currently divest, could attempt a multi-year engagement initiative, encouraging listed companies to improve performance on ESG issues, aiming to reduce the negative impacts of tobacco use as far as possible.
A new agenda for investors regarding tobacco could include: creating and using tobacco regulation stress-testing methodologies, stronger disclosure requirements (regarding marketing practices; ‘harm-reducing' product business strategy, R&D levels and product volumes; fines, legal costs and lobbying policies/practices), expanding and improving tobacco crop production sustainability standards, supporting the use of such standards as a condition for bank loans to the sector, supporting the creation of an Economics of Tobacco report modelled on the climate change Stern Review and considering how investors could support governments in enacting new and strengthening existing tobacco laws.
This report therefore examines the tobacco industry's investment returns, external societal costs and how investors are engaging with or divesting from the industry. You can download the full article here.
References: World Health Organization (2004) Tobacco increases the poverty of individuals and families
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