Cigarettes and the CPP

I don’t normally write about health-related issues but when the federal Health Minister ventures into the investing arena then it becomes a different story. Such was the case last month when Ujjal Dosanjh spoke to the annual meeting of the Canadian Medical Association in Toronto and voiced some rather tentative opposition to the Canada Pension Plan Investment Board holding shares of cigarette companies in its portfolio.

The media jumped on his comments, with one business columnist going so far as to accuse Mr. Dosanjh of thinking “it would be a good idea if Canadians were poorer in retirement”! Well, hold on a minute here. The minister’s remarks may have been off target but, as he was the first to admit, he knows nothing about this subject. So let’s put things in context and then look at the implications of such a suggestion.

For starters, the reference to cigarette companies and the CPP was not contained in the official transcript of his address. It was in the question period that followed that the CPP issue was raised by a doctor from Manitoba and he didn’t mince words. Here’s the official transcript of what he said.

“Mr. Mister, the failure of the Parliament of Canada to specifically prevent Canada Pension Plan contributions from flowing to the tobacco industry has led to the perverse situation where the Canada Pension Plan board has invested $100 million in the stock of numerous tobacco companies. In addition, the board has shamelessly obstructed the other shareholders in their attempts at forcing the tobacco industry to change its behaviour, including the blocking of a motion that would have informed pregnant women of the harm caused to them and their babies when they smoke. Will you as minister, working with the CMA and within your cabinet, pass legislation that would amend the Canada Pension Board Act to require it to divest itself of tobacco, of any and all tobacco industry holdings?”

Mr. Dosanjh was clearly caught off-guard by the aggressive tone of the question. It shows in his reply, which was hedged with all kinds of qualifiers.

“I think that is a very important question and I should not really address it lightly,” he said. “Let me tell you, I confess ignorance in terms of the complexity of the question, but it is my personal belief that I don’t think that any government activity ought to be going into the coffers of tobacco companies or enriching them. I was the attorney general and we sued the tobacco companies in British Columbia and that suit is still before the courts. I would certainly work with you and look into it and please help me figure out what the right thing is to do there.”

The bottom line is that the Minister of Health has no idea as to what, if anything, ought to be done about this situation. Perhaps I can help him out: do nothing!

Central issue not complex
The core issue is very simple: should the CPP Investment Board be restricted to buying only securities that meet certain tests of social responsibility? Or should its board of directors and money managers continue to have full latitude to invest wherever they find the most promising opportunities? It’s a debate that can be expected to provoke a lot of fire and brimstone on both sides if Mr. Dosanjh decides to seriously pursue the matter, which the CMA passed a resolution asking him to do.

After all, if we’re going to impose ethical screens on the CPP, why stop with cigarette manufacturers? What about companies in the alcohol business? That would eliminate such highly-successful stocks as Vincor and Andres Wines from consideration. How about businesses involved in some way with the military? Good-bye Magellan Aerospace, CAE, Bombardier, and a host of U.S. giants. Companies that profit from gambling should also be left out, so no MGM Mirage. Other types of businesses that might be precluded include those with questionable environmental practices (some forestry, oil, and mining companies would be knocked out by that), those in the nuclear business (TransCanada Corp. has an interest in the Bruce nuclear station), companies that are deemed to have poor labour relations, and firms that are seen to be deficient in corporate governance.

All of these screens are employed by one or more of the socially-responsible mutual funds that are available in this country. If Mr. Dosanjh decides that he wants to recommend that the federal government require the CPP Investment Board to adopt socially-responsible standards, he would be setting a course that could lead us into troubled waters indeed.

Don’t get me wrong. I am no fan of smoking. On the contrary, I have seen first-hand how addictive it is and the damage that it causes to health. I do not own any cigarette stocks, and would not buy any. But I do not extend that personal preference to the way in which public money is managed.

Canada has many options for people who feel strongly about socially-responsible investing, including two mutual fund companies that are dedicated to the sector: Ethical Funds and Meritas. However, the sad truth is that, with a few notable exceptions like the Ethical Special Equity Fund, many socially-responsible funds have underperformed in relation to their peer group. For example, the largest fund of this type, Ethical Growth Fund, lost an average of 0.25 per cent a year over the five years to July 31, compared to an average annual gain of 5.5 per cent for the Canadian Equity category. Perhaps it was due to an overly conservative approach by the managers (who were recently replaced) but the fact is that many socially-responsible equity funds show similar patterns. Is it because of the restrictions imposed on them? No one can say with certainty. But the question really is whether we want similar restrictions placed on the CPP.

The legislated mandate of the CPP Investment Board is “to achieve a maximum rate of return without undue risk of loss having regard to the factors that may affect the funding of the Canada Pension Plan and its ability to meet its financial obligations”. In other words, the key responsibility of the directors is financial, not social.

The CPP’s chief actuary has calculated that in order for the plan to meet its commitments and to maintain the employer/employee contribution level at 9.9 per cent of pensionable earnings, the investments must earn a real return (that is after inflation) of at least 4 per cent a year. As long as interest rates remain low, that cannot be achieved through traditional fixed-income investments like bonds. That’s why the CPP Investment Board was set up in 1998 and given the mandate to invest a portion of the assets in stocks.

It looked like a questionable decision when the CPP equity portfolio lost $4.1 billion in the fiscal year that ended March 31, 2003, which included the final throes of the bear market. But in the latest fiscal year, the equities more than made up that ground with a $7.2 billion gain, a 31.7 per cent rate of return.

Would those results have been compromised if the CPP was required to operate under a socially-responsible mandate? It’s impossible to say without a detailed actuarial analysis and even then it would be difficult because we can’t know what securities the managers would have chosen to replace those that didn’t pass the screens.

The question is whether Canadians feel strongly enough about socially-responsible investing to impose such restrictions on the fund. They certainly haven’t shown a lot of interest in doing it with their own money. Ethical Funds, the largest socially-responsible mutual fund group in Canada, has just $1.6 billion under management, placing it at number 25 on the list of member companies of the Investment Funds Institute of Canada in terms of total assets.

We should also not lose sight of the fact that if placing restrictions on the CPP Investment Board hampered its ability to achieve the target 4 per cent real rate of return, the administrators of the plan would have only two choices: reduce benefits or increase contribution rates even more. Either way, ordinary Canadians would foot the tab.

Mr. Dosanjh pleaded ignorance in his response at the CMA convention. My view is that when he learns the facts, this well-meaning but financially dubious idea should be put on the shelf.