I have previously quoted Keynes on liquidity: “there is no such thing as liquidity of investment for the community as a whole”. In fact, this post is an extension of my previous post in which that quote appears – Should we deliberately strand some of our assets? We will deal with this macro position at the end. But first we need to lay out the ground work.
Arguably the movement to divest tobacco holdings from institutional portfolios can be traced to an individual (well, it makes for better story – multiple influences within a complex system makes for poor narrative). Dr Bronwyn King is an Australian radiation oncologist who was treating lung cancer suffers and is now CEO of Tobacco Free Portfolios: “It was only during a meeting with a representative of her superannuation fund in 2010 that Bronwyn learnt some of her money was flowing to tobacco companies through the default option of her superannuation fund” (Source: https://tobaccofreeportfolios.org/). This is a flaw in the narrative, but a perfectly forgivable one. No money was flowing to the tobacco companies. Existing ownership rights were being shuffled between willing buyers and sellers, that’s all. Another quote from Dr King takes us back to the narrative: “In recognition of the profound death and disease caused by tobacco, there are 181 parties to the UN Tobacco Treaty, vowing to implement robust tobacco control regulations. In contrast, the global finance industry still invests in, and profits from tobacco. But this is changing…”.
So we have an industry that causes harm (yes, it can be argued that individuals exercise free will and harm themselves – true, but we tend not to give knives and matches to very small children). There is therefore an ethical case against the tobacco industry. But most of the global finance industry operates under a fiduciary duty, which comes from a history of ethics-free, finance-only decisions. So what does the financial case look like? History shows that these have been extraordinarily successful investments – if customers are compelled to buy your product (physiological addiction) it shouldn’t be too hard to make super-normal profits. So we will need to argue the future will be different in order to build a case against holding these assets. To me there are two, relatively clear components to the future returns. A very attractive stream of cash flows being thrown off by an existing business model supported by tied-in customers. And a very unattractive set of ‘externalities’ (essentially litigation or regulation) that could take most, if not all of those cash flows away. It would take a brighter mind than mine to combine those two elements into an expected value. My thinking would be more simplistic. I hold a diversified portfolio when I don’t know which assets will ‘go to zero’ (but some of them will). But if I know that a tobacco asset has a positive probability of going to zero over my investment horizon (and the cumulative likelihood grows ever larger as the horizon lengthens) why hold it? Part of compounding wealth is about avoiding drawdown, and there are lots of other assets I could hold instead, so why take the risk? So I believe I can construct a valid, financial-sounding (but in reality, ethics-infused) case for divestment. All good, but we are not done. There are bigger fish swimming here.
Back to Keynes. I can divest tobacco from my portfolio, but society can’t. If I sell my securities, I can only do so if there is a willing buyer on the other side. And so the tobacco business model continues largely unimpeded. It’s just that the returns and the risks now affect someone else’s portfolio. As a bit of an aside, Dr King’s superfund contributions were not funding this industry. But a previous generation of financial industry participants did fund it. Only back then, there were credible claims that smoking could even be good for you. The learning points from this aside would include humility regarding the limits of our knowledge, and the importance of genuinely long-term thinking. It is better not to fund an industry that causes harm, than to try to shut it down when it exists (and can lobby). But this would represent incredible foresight.
Back to the main narrative. This, the shuffling of ownership but continuation of operations, is not the result that Dr King desires, I presume. It can be argued that if enough people decide to divest there is an impact on the cost of capital to tobacco companies. Fine, but (1) they are no longer allowed to give money to advertising agencies, and (2) there is no point in capital expenditure to expand production. In short, they don’t need capital and so are unlikely to be bothered by a higher cost of capital. The truth is, tobacco is a dead business, and everyone knows it. You can in fact make a case that the returns from tobacco went from merely excellent to extraordinary at the time it became generally recognised that it was a dead business. There was nothing to do with the cash thrown off by continuing operations other than return it to shareholders. So, for me, divestment doesn’t achieve what is aiming for – the ending of this form of human suffering. The answer is to shut down the business model – which would entail a deliberate choice by brave shareholders to strand (short-term) financially-attractive assets. Or…, or…. we could persuade governments to nationalise the tobacco companies. This would give society the liquidity, the out, which is otherwise only achievable by stranding. And it would allow a government to manage the asset-liability problem as it saw fit, over the time horizon it deemed practical.
My final point relates to scale. Tobacco is a $517bn problem (global market cap). To me, fossil fuels are the same type of problem but an order of magnitude bigger ($5 trn). To the extent that we were able to agree that fossil fuels equally cause human suffering (or are about to), then we have exactly the same private divestment vs public externality problem. Therefore, we should probably start thinking about engaging with governments to nationalise fossil fuels under a mandate to wind them down. The private capital windfall could then be applied to funding new industries – hopefully with greater knowledge of potential future externalities.