CalSTRS rethinks tobacco taboo

Tobacco, once considered investment poison to California's biggest public pension systems, is poised to make a comeback.

The $172 billion California State Teachers' Retirement System today will consider adding tobacco stocks back into its portfolio. Nearly eight years ago it dumped all such investments, convinced that looming lawsuits, bankruptcies and government regulation would push investors to the exits en masse and pummel the industry's stock prices.

But those dire predictions didn't pan out – and CalSTRS figures it would have been up to $1 billion richer if it hadn't divested its tobacco holdings.

So despite objections from anti-smoking groups, CalSTRS officials say tobacco could again be a sound investment for the fund.

"In 2000 the marketplace was in such turmoil that the prudent action was to cut the potential risk," said CalSTRS spokeswoman Sherry Reeser. "Now we're in a completely different marketplace."

CalSTRS is the nation's second-largest public pension fund, behind the California Public Employees' Retirement System. Both funds dropped tobacco company investments in 2000.

Though controversial eight years ago, tobacco holdings weren't critical to CalSTRS. Only three of the 2,611 stocks it held in November 1999 were in tobacco companies, according to Knowledge Mosaic LLC, a Seattle-based financial research firm. Tobacco made up less than one-half of 1 percent of the fund's roughly $114 billion in assets.

Even if CalSTRS does jump back into tobacco investments, they would still probably make up a small portion of its portfolio. Tobacco represents about 1.7 percent of the Russell 3000, the benchmark CalSTRS uses to allocate the $65 billion in devotes to U.S. stocks.

Still, anti-smoking advocates oppose any tobacco investment by CalSTRS. About 4 million Californians smoke, according to Paul Knepprath, vice president of government relations for the American Lung Association, and "reversing CalSTRS' policy would be making money off the investments in a product that kills more Californians than any other product – including teachers."

He said that it is "hypocritical" for teachers to discourage students from smoking while their pension fund invests in companies that make cigarettes and other tobacco products.

CalSTRS officials say the fund has a responsibility to act in the best financial interests of its 812,000 members and their families.

"The trustees are legally obligated to make decisions to the exclusive benefit of the members," said CalSTRS spokeswoman Reeser. "It's their sole responsibility to act in the best interests of California's teachers and their families."

That means having a diversified portfolio that spreads risks. While tobacco gets plenty of attention, CalSTRS also has millions of dollars in other "sin stocks" found in the Russell 3000: gambling (Wynn Resorts Ltd.), adult entertainment (Playboy Enterprises Inc.) and alcohol (Molson Coors Brewing Co.)

"Tobacco has been the industry that has been widely debated over the years, though," said James Hawley, a business professor at Saint Mary's College in Moraga who follows CalSTRS. "The argument has been that it's a bad investment over the long run."

But much of that debate has died down, Hawley said. Litigation over tobacco's hazards hasn't crippled the $63 billion industry.

According to Morgan Stanley, U.S. tobacco companies had won favorable judgments in 74 percent of product liability suits by 2006. When the companies lost, the money they paid out wasn't overwhelming.

Government efforts to cut down on cigarette consumption and higher taxes on tobacco sales haven't hurt earnings either, CalSTRS found, because tobacco companies simply raised prices.

As a result, tobacco investors – including many pension funds – have held on to their stocks, Hawley said. Many of the companies have themselves diversified over the years, buying firms that sell beer and clothes and drill for oil, among other things.

Meeting at the fund's Folsom Boulevard headquarters, the CalSTRS board is scheduled to discuss whether to reinvest in tobacco stocks this afternoon. If it approves the move, it will cost about $4.5 million to move money from other investments, CalSTRS estimates. Fluctuations in tobacco stocks could add up to $5.7 million more as the market anticipates CalSTRS' purchases.

CalPERS, the country's largest public pension fund with nearly $250 billion in assets, hasn't made public any plans to reinvest in tobacco.

"We're monitoring the CalSTRS situation," said spokeswoman Pat Macht.

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