Is tobacco ESG-friendlier than Tesla? Funds, investors don't think so

ESG ratings have taken a hit amid the controversy about tobacco companies outperforming Tesla, but those questionable grades appear to have little meaning for funds and investors.

Last month, Tesla CEO Elon Musk criticized the notion of such ratings after The Washington Free Beacon published a report showing big tobacco doing well when it comes to ESG credentials while the electric car and battery company struggled. That report came after Philip Morris International CEO Jacek Olczak touted the company’s social responsibility initiatives to the Financial Times, telling the paper he believes that the tobacco company is on track to becoming an ESG-friendly stock.

Numerous tobacco companies in recent years have focused on vaping and other “smoke-free” nicotine products, claiming that those cigarette alternatives are less harmful to consumers. Companies also appear to have focused more on diversity, equity and inclusion, which in some cases has helped their ESG scores.

But if tobacco companies truly are more socially responsible, that trend might be lost on investors. Those who focus on ESG mostly want nothing to do with big tobacco.

In the U.S., just eight of more than 430 sustainability-themed mutual funds or ETFs have 1% or more of their total net assets allocated to stocks with any meaningful connection to tobacco, according to data that Morningstar Direct provided to InvestmentNews. Most of those funds hold stocks in companies with some retail sales of cigarettes as a small percentage of their business.

“It can be surprising to see sustainable funds with tobacco exposure, since it has long been a common exclusion applied by sustainable or socially responsible funds,” said Alyssa Stakiewicz, associate director of sustainability research for Morningstar Research Services, in an email.

Among actively managed sustainable U.S. funds, there are four that include investments in tobacco-producing companies Altria, Philip Morris or Imperial Brands. Those include the FCF US Quality ETF, FCF International Quality ETF, Victory Sustainable World Fund and Russell Investments Sustainable Equity Fund. None of those four funds include screens that would prohibit tobacco companies, Stankiewicz said.

The fund with the highest exposure to companies that sell tobacco products, the $92 million Quantified Common Ground Fund, has about 4% of its assets in such stocks, the data show. The biggest fund with more than 1% of tobacco exposure, the $2.8 billion Calvert Small-Cap Fund, has about 3.4% of its assets connected to that industry.

The Calvert fund has exposure to tobacco sales on the retail side, through holdings that include Wyndham Hotels and Casey’s General Stores, for example, Stankiewicz noted.

NOT ON AUTO PILOT

Despite Musk’s response on Twitter that “ESG is the devil,” Tesla is a common holding in sustainable funds. Last year, when Tesla was dumped from the S&P 500 ESG Index amid low corporate governance ratings, Musk became vocal in his criticism of ESG as a concept, pointing out that ExxonMobil remained in the index.

Among the list of sustainable funds provided by Morningstar Direct, 83 include allocations to Tesla stock of more than 1% of their portfolio assets. Two of those funds, the VanEck Low Carbon Energy ETF and First Trust NASDAQ Clean Edge Green Energy ETF, each have more than 10% of their assets in Tesla.

Comparing the ESG scores of tobacco firms to those of a car maker isn’t apples-to-apples, but the differences in how the companies are rated show potential problems with both corporate disclosure and the standards used to set ESG scores.

“All this points out is the problem of the lack of transparency,” said Andy Behar, CEO of As You Sow. “Companies are very lopsided … The quality of the data is very poor, because the SEC doesn’t require disclosures that are accurate and presented in a standardized format.”

That goes beyond tobacco, with corporate giants like Coca-Cola praised for recycling and virgin plastic programs, despite making products that help contribute the obesity epidemic, Behar noted. It’s also complicated by the fact that big companies are involved in multiple industries, with Ball Corp. making everything from jam jars to aerospace defense products, he said.

“We believe in the freedom to invest. You need to make your personal choices and balance that out,” he said.

Even so, “I do not think that tobacco should be in an ESG portfolio, even if the companies treat their employees well,” he said.

Telsa, of course, has its own problems.

“Product-wise, they are innovating, just on the batteries,” Behar said. “They’re doing amazing things. [But] they are just the most arrogant company out there. They won’t disclose anything. We have no idea about their water use.”

Recently, Musk said during the company’s annual meeting that it will look into the issue of child slave labor tied to the elements mined for its batteries, an issue brought up in a floor resolution, which was an encouraging development, Behar said.

ENGAGEMENT AND DIVESTMENT

Institutional investors — who often consider ESG data — tend to exclude companies or industries they see as having negative effects on humanity or the environment, including oil companies, private prisons, tobacco firms and alcohol producers. But those investors also sometimes hold small allocations in such companies in order to engage with them.

The Sisters of St. Francis of Philadelphia, which has a fund representing 300 Catholic women who are part of the organization, screens out tobacco, said Tom McCaney, its director of corporate social responsibility.

“I’m very cynical that these companies say their big interest in a tobacco-free world. The vaping and [smokeless] products may be somewhat less destructive to your health, but they still enslave the user to a lifetime of addition. There is zero benefit,” he said.

However, the organization runs a smaller account outside of its main portfolio for the purpose of investing in companies that it wants to help change. And that includes tobacco companies, McCaney noted. Through the Interfaith Center of Corporate Responsibility, the group engages with tobacco companies such as Philip Morris, Altria and British American Tobacco, as well as with pharmacies and retailers such as Kroger that sell the products.

“I think it matters that they’re trying to do some things more responsibly,” he said. “As long as it’s legal to sell tobacco, they should be trying to do things as responsibly as possible.”