By Christopher Palmeri
Nothing better illustrates the folly of letting politicians loose on investment decisions than what has been happening in California. In late 1999, ambitious State Treasurer Philip Angelides seized upon socially responsible investing as a way to make his mark. He argued that as well as undermining the public health, tobacco companies face legal and regulatory challenges that could bankrupt them. Angelides helped persuade the boards of California's two largest pension funds to sell their $800 million in tobacco shares.
Since Angelides began his crusade, the American Stock Exchange Tobacco Index has more than doubled--and Philip Morris Cos. (MO) was the best-performing Dow Jones industrial average stock in 2000. The reasons? The companies boosted revenues by raising cigarette prices, and Wall Street cheered restructuring moves such as R.J. Reynolds' sale last year of its Nabisco operations and the upcoming initial public offering of Philip Morris' Kraft Foods Inc. unit (page 160). There was also a perception in the market that the worst was over for tobacco companies, in part because of a $246 billion master settlement with all 50 states.
BusinessWeek estimates that two California state pension funds could be as much as $447 million out of pocket due to the lost appreciation of their tobacco shares. That assumes the the California State Teachers' Retirement System (CalSTRS) netted the average price of the stocks during the five months it took to unload them. The same method was used for the California Public Employees' Retirement System (CalPERS), which is still in the process of divestiture. Those estimates don't even count transaction costs and the likely poorer returns from reinvestment of the tobacco proceeds in the overall market. A spokesperson for CalPERS disputed the estimate, while the teachers' pension system declined comment. Neither would disclose the actual numbers.
All the same, Angelides is undeterred. "These investments don't make sense from an investment standpoint or given the ill effects the products are having on society," he says. "Continuing pressures on the industry make tobacco investments risky over the long term." Indeed, tobacco companies do still face a host of legal challenges including a Justice Dept. suit and a large private judgment in Florida now on appeal.
STAINED FINGERS. Nor is California alone in what it's done. In all, nine states have divested or limited the tobacco investments of their pension funds, selling off more than $3 billion worth of shares in the process. And some other local pols have been as vehement in their advocacy of divestiture as Angelides. "It's hypocrisy for the state to be holding $400 million worth of tobacco stocks while we are suing the tobacco companies," State Treasurer Barbara Hafer said during Pennsylvania's divestiture debate in 1997.
That's not the only hypocrisy involved. States have long had huge financial interests in tobacco, stretching well beyond the returns on their pension funds. They collect some $12 billion in cigarette taxes each year. And the $246 billion master settlement has given them an even greater stake in Big Tobacco's viability. In the last year, five state legislatures have, at the prodding of tobacco companies, passed laws that limit the sums businesses have to post as bonds when they lose product liability cases.
Indeed, political winds shift almost as quickly as the stock market. For example, Florida initiated the largest state tobacco divestiture, $835 million in 1997, under then-Governor Lawton Chiles, a Democrat. Now, with Republican Governor Jeb Bush, Florida is considering reinvesting in tobacco shares. Maryland and Kentucky, which began divesting in 1996, already have. "To ignore politics in socially responsible investing is to ignore the 800-pound gorilla in the room," says Douglas G. Cogan, director of tobacco research at the Investor Responsibility Research Center, a nonpartisan group that advises large pension funds.
That may be, but state pension funds are being steered into treacherous waters when political grandstanding forces them to mix controversial social goals with their clear financial mandate. As the ill-timed divestiture in California shows, politicians should set only the broadest investment guidelines for state funds and leave the stock-picking to the pros. Palmeri covers finance from Los Angeles.