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March 20, 2003
Tobacco-Free Investments Avoid an Industry of Smoke and Mirrors
    by William Baue

As court cases related to deception by the tobacco industry mount, individual and institutional investors have options for avoiding exposure to tobacco stocks.

This week, the U.S. Department of Justice filed more than 1,400 pages of documents in the United States v. Philip Morris et al. case, demanding $289 billion from the tobacco industry on charges of fraud and dangerous marketing practices. The case, which dates back to 1999, is under appeal by the five tobacco companies named as defendants.

This amount eclipses the 1998 Master Settlement Agreement, which requires tobacco companies to pay 46 states $206 billion, and the related settlement that requires tobacco companies to pay the remaining four states $40 billion.

Informed observers expressed skepticism that Judge Gladys Kessler of the Federal District Court will grant such a sizable award. However, investors registered concern in the wake of the news, as stock prices fell for all five companies. The defendants include Altria subsidiary Philip Morris (ticker: MO), R.J. Reynolds (RJR), Loews (LTR) subsidiary Lorillard Tobacco, British American Tobacco (BATS.L) subsidiary Brown & Williamson, and Vector Group (VGR) subsidiary Liggett Group.

"Why would anybody invest in a terminal industry?" said John Montgomery, president and director of Bridgeway Funds. "We just don't."

"Our longterm view on tobacco is that it's bad for individuals, it's bad for a country, it's bad for an economy," Mr. Montgomery told

Bridgeway screens only tobacco from its family of funds. One of its funds, the Bridgeway Aggressive Growth Portfolio (BRAGX), gained 13.23 percent in annualized returns over the past five years. Another, the Bridgeway Ultra-Small Company Portfolio (BRUSX), grew by 9.91 percent over the same five-year period.

Bridgeway also acts as sub-advisor to one socially responsible investment (SRI) fund, the Calvert Large Cap Growth (CLGAX). The fund was launched two and a half years ago, thus precluding five-year results. Since inception, the Calvert fund has lost 21.86 percent in annualized returns; during the bear market, it has lost 5.88 percent in annualized returns.

Most mutual funds that screen only tobacco specifically try to avoid being labeled as SRI. Such funds include the American Mutual Fund (AMRMX), which gained 1.43 percent in annualized returns over the past five years, and the flagship Pioneer Fund (PIODX), which lost 1.64 percent over this same five-year period.

Likewise, many social investors do not consider single-screen funds such as tobacco-free funds to be SRI. However, almost all SRI funds include tobacco among their screens.

While individual investors can avoid tobacco through tobacco-free funds or broadly-screened SRI funds, institutional investors can also screen tobacco from their portfolio without fear of lapsing in their fiduciary responsibility. So said the Investor Responsibility Research Center (IRRC) in its 2000 publication, Tobacco Divestment and Fiduciary Responsibility, A Legal and Financial Analysis.

"We came to the conclusion that an institution can be within the bounds of its fiduciary duty to divest its tobacco holdings, mainly on the basis that it would not have more than a de minimis effect on the performance of the overall portfolio, either positive or negative," said Doug Cogan, director of IRRC's tobacco information service. A de minimis effect is an inconsequential difference in return.

While the U.S. v. Philip Morris et al. case is important to watch regarding the future of the tobacco industry, Mr. Cogan believes that a more important case may be the Engle case in Florida, so-named after lead plaintiff Howard Engle.

"It's the one that brought tobacco company shares down to rock bottom back in 2000," Mr. Cogan told "Tobacco stocks never got back to the previous highs that they had reached."

"It was a little bit more than a dead cat bounce," Mr. Cogan added. "If you drop a dead cat from a high enough building, it'll bounce when it hits the ground, but not much."

Florida's Third District Court of Appeal is currently considering whether to uphold the jury's award of $145 billion to Florida smokers.

"If that judgment is upheld on appeal, the tobacco companies themselves have said that they would not have the resources to make the payment in a lump sum, and therefore would have to declare bankruptcy," said Mr. Cogan.


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