OPINION | The California Public Employees Retirement System (CalPERS) board meeting was broadcast live from California on Monday, December 19, 2016, presenting an opportunity to watch the body deliberate as to whether it should reverse its tobacco-free investment policy or extend the restrictions to all externally managed funds, which would capture a further US$547 million ($754 million).

The board decided to maintain and extend the restrictions on tobacco investment. The public health community and politicians lauded this decision, with California state treasurer John Chiang stating, “Today, we not only successfully fought back misguided efforts to lift CalPERS’ 16-year-old ban on direct tobacco investments, but also we ended the system’s inconsistent position of allowing outside partners to quietly make such investment on its behalf.”

A majority of the CalPERS investment committee, consisting of every member of the governing board, supported the motion, with three of the nine directors voting against. The dissenting directors were obviously compelled by the recommendations their staff and external consultants made as they attempted to separate the societal and ethical considerations from the financial (a big ask for the health community).


The fallacy of universal agreement

During the deliberations, Allan Emkin, of the Pension Consulting Alliance, addressed the board. He followed Dr Stanton Glantz, a professor of medicine, director of the University of California, San Francisco Center for Tobacco Control Research and Education, and the author of more than 350 scientific papers.

Emkin said, “There is one agreed principle in the investment community – that diversification manages risk.” He then quickly concluded, “Therefore, divestment reduces opportunity.” The situation seemed clear: diversification is good, divestment is bad, and it’s as simple as that – everyone agrees.

But do they?

This tactic of economists and financiers presenting their positions as universal and incontestable truths is common. The many assumptions and qualifications that underpin economic theories and investment positions tend to be reduced or omitted completely. This strategy contrasts markedly with the public health and science community, which routinely addresses counter-arguments and explains the rigour behind positions. This variance in approach was evident at the CalPERS meeting, as investment advisers attempted to create a certainty that did not necessarily exist.

There will, of course, always be counter-arguments to any held belief, even if it is considered fact or truth. For example, despite the US Surgeon General declaring in 1964 the link between tobacco and poor health outcomes (based on more than 7000 articles), today British American Tobacco claims the following on its website: “To date, scientists have not been able to identify biological mechanisms that can explain with certainty the statistical findings linking smoking and certain diseases.”


Diversification argument simplistic

Like almost all issues we face, diversification is not black and white. Emkin claimed that greater diversification reduces risk by definition, with a nod to a classical, Harry Markowitz-style, mean-variance view of the world. This is overly simplistic. In reality, the benefits of diversification may be achieved with relatively few securities. Indeed, diversification for its own sake may contribute nothing in terms of risk mitigation while lowering returns (thus legendary investor Peter Lynch’s neologism ‘diworsification’). Further, Emkin’s presentation offered little discussion of the specific risks of investing in tobacco companies, merely an assertion that their presence in a portfolio would add diversification benefits.

Diversification presents one way to manage risk but not the only way. Analysis of environmental, social and governance factors and investing with a long-term lens, so that prospective risks are not merely acknowledged but truly accounted for, are other ways to reduce risk in an investment portfolio.

There are now plenty of examples of funds that perform well that either enforce exclusions or are considered not diversified. The Responsible Investment Association Australasia went so far as to declare in its 2015 Benchmark Report that “once again … the myth of underperformance of responsible investments is unfounded”.

Those attempting to make a purely financial case against divestment in tobacco tend to oversimplify the situation. They set aside very real risks and considerations in relying on past performance (easier to measure) rather than future expectations (uncertain) and they most often completely ignore the devastating impact of the product.


What’s at stake

Divestment is the role the finance community can play in addressing what the World Health Organization calls the “global tobacco epidemic” that will cause the deaths of 6 million people this year. It’s not just about what divestment might achieve in terms of increasing the cost of capital or forcing the industry to fold, it is about joining governments and our health and education sectors as they attempt to de-normalise and stigmatise an industry that has continued to actively encourage new consumers, namely children.

We can debate the certainty of risks and returns, but maintaining that investment in tobacco is in the best interests of ordinary workers is clearly becoming an increasingly difficult position for directors to hold.

We should all hope that a tobacco-free position becomes a certainty. 

Clare Payne specialises in ethics in banking and finance. She initiated – and is now a director of – The Banking and Finance Oath (thebfo.org) and holds the positions of chief operating officer with Tobacco Free Portfolios and Fellow for Ethics in Banking and Finance with The Ethics Centre.

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