Trust Us, We’re Kool: A Cautionary Tale for ESG Investors Who Actually Care

Philip Morris International, the non-US manufacturer and distributor of the Marlboro cigarette brand, announced in August 2021 that it would be issuing an ESG bond.1 Yes, you read that right.

Before we get into their “transformation” – their term,2 not ours – a little bit of history is in order. Philip Morris International was spun off from Altria Group, the rebranded Phillip Morris parent company. The name was changed nearly 20 years ago, though the company claims that this was not done to run from the negative repercussions of the bad behavior of its iconic cigarette business. At the time, the company also owned Kraft Foods and beer producer Miller, and the argument was that the company was more than just tobacco. This made sense; being viewed as only tobacco wasn’t a great recruiting tactic, certainly not for any openings they may have had on the PR team. Within about a year, Altria had sold Miller and brought Kraft Foods public in an IPO as the first step toward disposing of it as well. This left Altria as a rebranded tobacco company, and though we don’t know for sure whether that was the goal of the rebranding all along, that PR team certainly couldn’t have been too upset about the outcome.

Not long thereafter, Altria spun off Philip Morris International (PMI). The reasons were clear: Wall Street was clamoring for the company to unlock shareholder value by freeing the international subsidiary from “the legal and regulatory constraints facing its domestic counterpart.”3 Put another way, the origin story of PMI certainly wasn’t particularly noble. Altria retained Philip Morris USA, and since then, has made investments in Juul and other smoke-free offerings. Their public persona is similar to that of PMI, so much so that, with US-based litigation and restrictions seemingly in the rear-view mirror, Altria attempted to merge with PMI, allowing the former to benefit from stronger cigarette sales in emerging markets while providing access to the rapidly growing US vaping market to the latter. Ironically, health issues associated with Juul and revelations that the rapid growth was at least in part due to aggressive marketing and product development targeted at children4 led to the two companies scrapping their merger plans, for now.

So here we are, with a company who gets a large majority of its revenue from cigarette sales but hides those product lines on its website attempting to issue what it unironically calls “business transformation-linked financing” to try to get their company, if not their entire industry, off the ESG naughty list. After all, most ESG investors explicitly exclude the tobacco sector from their portfolios. But the trick here is that this move is not intended to appeal to ESG investors whose capital is ultimately used to buy the bonds. It is intended to appeal to ESG investment managers who deploy that capital on behalf of those investors.

The truth is that ESG investing is hard. It is not so hard that one can’t see through the poorly veiled cynicism with which PMI is attempting to tap a growing source of capital that, at worst, is a PR win for the company. At the same time, this effort could potentially insulate PMI from reduced access to more traditional capital markets, especially in Europe where it is based and where investors are rapidly mainstreaming ESG mandates. But properly evaluating key ESG risk factors for an issuer takes a lot of work.

Moreover, since ESG risks do not have standardized disclosures like financial information does, explaining strategies to clients often requires that an investment manager be willing to educate. This is why many managers choose to outsource their ESG work to third parties or simply resort to negative screening, which research has shown to be a poor approach to ESG.5 By doing so, these managers have plausible deniability if a portfolio company behaves irresponsibly. It gives them someone or somewhere else to blame. That said, if that someone else is not doing the work themselves, or if the rules governing what is and isn’t appropriate aren’t sufficiently rigorous, those managers face a different risk: being accused of greenwashing their portfolios.

For those who aren’t familiar with the term, greenwashing is the act of making investments which only superficially appear to fit a sustainability mandate. By doing so, a manager may have many clients who don’t notice that they have a number of irresponsible issuers in their portfolios. This is very likely in portfolios for which the ESG effort is largely the result of a negative screen of “bad” sectors.6 This is also likely among those managers who have outsourced their ESG research, but not for the same reason. Indeed, third party services give an air of credibility and rigor to a due diligence conversation. That said, we would ask readers to consider if they would invest with a manager who only buys stocks rated “Buy” by the research team at Bank of America Merrill Lynch. Or perhaps, they would prefer a manager who only buys stocks rated “Buy” by the research team at JP Morgan. What happens if the two research teams disagree? Which manager is better

This example will strike some readers as absurd, and it should. But it is no different from hiring an ESG manager who relies on an outside party to do their ESG research. ESG factors are risk factors, and managers are hired to evaluate risks. If that work isn’t native to the investment process and is instead simply an overlay or filter based on some external determination not ingrained in the manager’s risk philosophy, then greenwashing is not just a possibility but a likelihood.


By Venk Reddy
Originally published in Q3 2021 letter

1 For those astute readers who paused long enough to Google the Kool cigarette brand, we know it’s not made by Philip Morris, but we couldn’t let a minor distinction without a difference get in the way of a perfect headline.

2 The first menu item on their website says so. We also find this entire site to be painfully desperate. Over 70% of their 2Q21 revenues were from traditional combustible products (i.e. cigarettes), but the marketing and legal teams have ensured that those brands are nowhere to be found.

3 "Altria to spin off Philip Morris International". NBC News. Associated Press. 29 August 2007.

4 Seriously? Does anyone bother to learn from the past anymore?

5 For more on this, I encourage you to review the Wharton research we cite in our piece, "ESG: A Data-Driven Definition".

6 Asking the question is often not sufficient to determine if this is a manager’s primary method of ESG “research.” Most investment management firms are skilled at saying one thing and doing another. We urge readers to push their managers in due diligence and force them to discuss examples and detailed processes to separate the sincere from the insincere.

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Zeo Capital Advisors is a fundamental investment manager with a short-duration credit mutual fund, a sustainable high yield mutual fund and separately managed accounts. Venk Reddy authored this piece and is the Chief Investment Officer and founded Zeo Capital Advisors in 2009.

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