Will the Largest Public Pension Fund in the U.S. Have a Tobacco Relapse?


After divesting from tobacco sixteen years ago, the nation's largest public pension fund has been in recent discussions regarding the reinvestment of tobacco back into its portfolio.


The implications are tremendous.When California Public Employees' Retirement System, more fondly known as CalPERS, divested its tobacco holdings in the year 2000, the act propelled a movement on behalf of pension funds and other institutional and individual investors to similarly rid tobacco stocks.At the time, CalPERS claimed this decision was made for financial, rather than moral, reasons, as the tobacco industry was in the midst of settling massive legal liabilities, largely instigated by the landmark 1998 Master Settlement Agreement between the five largest tobacco companies in America, 46 states, the District of Columbia, and five U.S. territories, a settlement that cost the industry northward of $200 billion dollars.

CalPERS2CalPERS, a $291.2 billion AUM pension fund, manages assets on behalf of public employees working in the state of California. The pension fund has been a frontrunner in the impact investing arena for years, selling Iran and Sudan holdings in 2011, gun holdings in 2013, and becoming subject to California legislature last year that required complete divestment of coal-producing companies by June of 2017.THE TOBACCO BUSINESS:Last September, consultant Wilshire Associates conducted a robust divestment analysis for CalPERS, determining that the opportunity cost of tobacco exclusion through December 31, 2014 was equivalent to $3.04 billion. Wilshire Associates additionally projected that the annual impact of continued tobacco exclusion would be $112.6 million in the short-term (1-5 years) and $172.1 million over the next 1-20 years (CNBC).CalPERSIndeed, Big Tobacco stocks have soared. Despite the billions inflicted upon the industry from the 1998 settlement and the fact that cigarette smokers have declined in volume, cigarette makers have found growth in emerging markets, and investors are seemingly attracted to the industry's steady dividends amidst such a low interest rate market environment.From 2005-2015, the MSCI World Tobacco Index achieved over 309% in total returns, as compared to 172% return from MSCI World Consumer Staples Index (Wall Street Journal).tobacco indexShort-term returns have also proved to be profitable: the share prices of the first and second largest tobacco companies, Philip Morris International, Inc. and British American Tobacco PLC have been up 18% and 13.4%, respectively, over the last 12 months.Yet, "The tobacco industry inflicts more than $23 billion a year in health care and lost productivity costs upon Californians, including $3.5 billion in direct costs to California taxpayers to pay for treating tobacco-related diseases afflicting Medi-Cal patients" (The Sacramento Bee).A CONFLICTED BOARD: The investment committee, comprised of every single CalPERS' board member, seems to be divided on the issue. On Monday, April 18th, the committee voted to begin a 1-2 year study on the pros and cons of tobacco investments, due to the aforementioned findings from Wilshire Associates.Two days later, the committee postponed the plan, indicating intent to revisit the discussion on May 16th. Typically, all decisions made by the investment committee require approval from the entire Board, but not this time.Investment committee chairman, Henry Jones, was asked by State Treasurer representative, John Chiang, to postpone the decision for a month. Why 30 days makes any difference is beyond me, but Jones acquiesced.
"No public pension fund should associate itself with an industry that is a magnet for costly litigation, reputational disdain, and government regulators around the globe." - John Chiang.

The Board is divided between those adamant on the evident loss in profitability and others who feel that reintroducing tobacco would go against everything CalPERs stands for. Not only is the pension fund a public advocate for socially responsible investing, but CalPERS also plays a separate role providing health insurance to its 1.6 million members. Should a health insurance provider simultaneously be fueling money into tobacco companies? For this very reason, CVS Health eliminated tobacco from its shelves on September 3rd, 3014. That being said, CVS Health is a retailer and health care company, not a pension fund managing assets on behalf of beneficiaries."We are sensitive to the policy issues surrounding divestment causes. But we're also obligated to ensure that we maximize our investment returns on behalf of our members."

- Henry Jones, Chairman of the CAlPERS Investment Committee.

Yesterday, May 16th, the Board revisited the tobacco issue, concluding that the anticipated 1-2 year study would be completed in six-nine months.View Communications & Stakeholder Relations Press Release here."We will now move forward with a review of tobacco and the tobacco industry, and consider data, studies, and stakeholder feedback to make a thoughtful and responsible decision. Our action today is not a decision to reinvest in tobacco. Rather, it is nothing more than a decision to move forward with a review of the issues, consistent with our fiduciary obligation to our members and contracting employers." - Henry Jones.The CalPERS Board will continue developing its new loss threshold policy for all of its divestments. The policy sets a loss threshold, such that losses beyond the threshold trigger an automatic review of divested assets in an open Board session.

Does the legally binding fiduciary duty impede socially responsible investment?

It is a question that has been widely debated for years."In my mind, in our belief statement and in our California Constitution, our obligation as the investment office is to consider what is in the best fiduciary interests of our beneficiaries." 

- Theodore "Ted" Eliopoulos, Chief Investment Officer, CalPERS.

Pension funds, charged with the responsibility of managing investments on behalf of teachers, firefighters and other state employees, are legally bound by a fiduciary duty, the obligation to act with prudence and loyalty.A fiduciary relationship arises when one party, "the fiduciary", acts on behalf of another party, "the beneficiary", while exercising discretion with respect to critical resources belonging to the beneficiary.The law forbids a fiduciary from acting in any manner adverse or contrary to the interests of the client, or from acting for his/her own benefit in relation to the subject matter.The reason socially responsible investment under a fiduciary duty obligation has been debated is because "a client's best interests" is subjective: in the case of excluding an asset that has resulted in a lost investment opportunity of $300 billion, is it in California employees' best interests to achieve greater returns on their pensions? Or, is the curtailment of smoking in everyones' best interest? Could the lost profitability be gained through investment in another, non-sinful investment? Probably. What happens when the same investment portfolio serves multiple clients with differing interests? The complexity deepens.We believe strongly we need to have a place at the table to influence those companies to act responsibly.  - Henry Jones, Chairman of CalPERS' investment committee.There exists another interesting school of thought, such that excluding certain companies from an investment portfolio is actually more detrimental than investing in said companies, because the former approach means that the investor cannot engage with, and positively change, the negative aspects of such companies. Is this just a rationalization for the desire to invest in "negative" companies that are profitable? Doesn't this strategy pose a conflict of interest: why would an investor attempt to change a business that is making it money? Or, is this truly a legitimate means to fix the system? Separately, is this the role of a fiduciary? These questions exist as continuous sources of debate.THE IMPLICATIONS:CalPERS will take the next 6-9 months to examine the issue before taking any investment action, but this conversation has already instigated massive controversially among other institutional investors, industry shareholders, health groups, and beneficiaries of CalPERS.Last month, the American Cancer Society, American Heart Association, and the American Lung Association joined forces to send a letter to Rob Feckner, President of the CalPERS Board of Administration.

"We are extremely disappointed to learn that the California Public Employees Retirement System is considering reversing a decision made 16 years ago to divest from tobacco companies. Investing in tobacco would pit CalPERS's portfolio against the financial and physical well-being of its members and the rest of California....every dollar we invest in the tobacco industry helps it addict more of our youth to a product that will ultimately harm them, rob thousands of their lives, and cost all of us billions of dollars in health care expenses. It is simple: investing in Big Tobacco may bring in some additional funds, but at what cost? We respectfully urge you to continue with the current policy and send a message that the health of California's kids is not worth trading for tobacco profits."

- American Cancer Society, American Heart Association, American Lung Association.

The herd mentality of investors magnifies the implications of big players, like CalPERS, making certain investment decisions. As such, other pension funds have commenced similar divestment analyses on their portfolios.To state that the act of CalPERS reintroducing tobacco into its portfolio will propel a series of reinvestments in once excluded, seemingly negative assets might be overly pessimistic, but such an outcome is certainly feasible.

1998 tobacco settlement: banned the advertisement, promotion, and labeling of tobacco products and required tobacco companies to develop, at their expense, websites showcasing all smoking and health related lawsuits. The settlement was tremendously costly, mandating perpetual industry payments to the states, an amount that would accumulate to northward of $200 billion through the year 2025. The tobacco industry was also required to pay $25 million per year, for ten years, to a charitable foundation designed to develop programs to reduce substance abuse, teen smoking, and diseases associated with tobacco use, and to reimburse states for all expenses related to government attorneys. (State of California Department of Justice, Office of the Attorney General).AUM: Assets Under ManagmeentDivestment: the reduction of an asset, or sale of existing business; the opposite of an investment.Sources: Wall Street Journal, CNBC, calpers.ca.gov, Pension & Investments, The Sacramento Bee, State of California Department of Justice, Office of the Attorney General, D.G. Smith, “The Critical Resource Theory of Fiduciary Duty” (2002) 55 Vand. L., B.J, Richardson, "Do the Fiduciary Duties of Pension Funds Hinder SRI?