In April a confused group of UK local government pension funds sought the opinion of Nigel Giffin QC on whether or not it was legal to omit tobacco stocks from their portfolios. Giffin concluded local government pension funds could not ditch tobacco holdings if there was a financial disadvantage in doing so, but if a case could be made for substituting tobacco stocks for other company shares that deliver the same financial returns, then there was no legal impediment to taking tobacco out – a view reinforced in the Law Commission’s review on fiduciary duty published in June. The review was groundbreaking in that it arguably paves the way for pension fund members to be able to propose divestment from tobacco and other ‘sin stocks’.
SACRIFICING RETURNS?
So if a trustee board is legally allowed to replace tobacco then how expensive is the cost of not having it? Furthermore, what can pension funds invest in to deliver the same financial returns?
Opinion on this differs widely. According to James Bevan, chief investment officer at CCLA Investment Management, a specialist investment manager for charities, faith organisations, and local authorities, there are ways around investing in tobacco while still achieving a comparable return as tobacco only constitutes a small proportion of global indices.
Bevan observes that in the 12 months to the end of July 2014 tobacco only accounted for about 1.25% of the share of the FTSE All World index, meaning there are a lot of countries which have very little exposure to the crop. Furthermore, looking at the returns from the All World index at sector level for the 12 months to the end of July, the All World index returned 4.68% in sterling terms, whereas the tobacco sector returned just 0.41%.
However, in the UK the share of the index made up by tobacco jumps to around 5% which makes it a more material decision for trustees looking to access that market.
Nevertheless, Bevan adds: “The world index outperformed tobacco by more than four percentage points. It is not the case that you have to be invested in tobacco if you want to get a reasonable financial return.”
Yet Jonathan Spencer, chairman of the Church of England Pensions Board, which like the Church Commissioners is advised on its investment policy by the EIAG, feels differently. “We would say we suffer detriment to the tune of about 0.5% a year because of the ethical investment policies,” says Spencer. “It is small but we can live with it comfortably enough. Most of it has probably been because tobacco has outperformed.”
Church Pensions Board chief investment officer Pierre Jameson adds: “We have outperformed major indices anyway. We have been able to construct a portfolio that offsets the lack of opportunity by not being able to have 5% or 10% in the market, but it is not a number we care to calculate because we are the CofE and have no choice in not being able to invest.”
Meanwhile, Mason of the Church Commissioners also accepts there can be a financial impact over the shorter term if certain sectors and stocks are excluded, but he adds picking the right manager is crucial to minimise losses.
He says: “We have some passive and some active equity mandates and all out passive investment is against ethically-adjusted benchmarks so it is easy to track the performance impact of exclusions on that. Over a period where markets have been defensive you will often find there is a negative impact in not investing in, for example, tobacco and defence. With active managers it is an opportunity cost. It is hard to measure the exact impact but from talking to our managers globally they are confident in their ability to generate the returns they do for their other clients regardless of our ethical restrictions.”
Despite the restrictions, the Church Commissioners has outperformed both its RPI +5% target and the WM All Funds Universe over three, five, 10 and 20 years.
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