The average exposure of Article 9 funds to tobacco products has grown, while Article 8 funds have steadily increased their holdings of alcohol assets
According to Morningstar data, there has been a spike in the average holding of tobacco by Article 9 funds since June 2023. Under the EU’s Sustainable Finance Disclosure Regulation, Article 9 funds must invest entirely in sustainable assets.
“A large portion of the [Article] 9 funds that have increased their exposure to tobacco activities since June have an emerging markets focus,” Jefferies analysts write in a research note commenting on the data.
“Many emerging market businesses in this sector have exposure to multiple revenue streams or will be owned as ESG improvers,” says Shannon Lancaster, funds analyst at investment manager Ravenscroft, in response to the surge of Article 9 funds’ holding of tobacco.
“It is likely some funds that have exposure to them will be engaging to improve multiple ESG metrics and reduce exposure to tobacco. It stresses the importance of understanding what is in the fund and what role it plays in your portfolio.”
In May, Jacek Olczak, chief executive of tobacco giant Philip Morris International, told the Financial Times that the company was pushing to become an ESG stock as it shifts from cigarettes to vaping products.
Though Miranda Beacham, head of ESG for equities and multi-asset at Aegon Asset Management, says: “It is simply not possible for some industries to change to an extent that would meet the sustainable standards required by funds that are interested in outcomes for health and the environment.
“You will not be finding any tobacco companies in any of our sustainability-themed funds for the foreseeable future.”
More ‘sin’ stocks
Meanwhile, the average holding of alcohol companies, which with tobacco are considered “sin” stocks, in funds that are designed to invest sustainably has fallen, following a mass downgrade of SFDR funds.
Under the regulation, Article 8 funds are those that more broadly promote sustainable characteristics, rather than solely focus on ESG.
The SFDR has a broad definition of “sustainable investment”, regarding these as investments “in an economic activity that contributes to an environmental or social objective, provided that the investment does not significantly harm any environmental or social objective and that the investee companies follow good governance practices”.
While some ESG funds exclude alcohol stocks on ethical grounds, Article 8 funds have much larger exposure to alcohol activities than any of the other “sin” activities, according to analysts at Jefferies. Alcohol accounts for around 1.5 per cent of portfolios on average, compared with circa 0.45 per cent for aerospace and defence, 0.2 per cent for tobacco, and 0.2 per cent for gambling.
Over the past three years, Article 8 funds have been gradually increasing their exposure to the alcohol industry, surpassing that of Article 6 funds, which only commit to including ESG factors in their risk considerations.
“The drop in alcohol involvement for Article 9 in January 2023 can be attributed to the reclassification of about 350 Article 9 funds to Article 8 funds,” says Morningstar global director of sustainability research Hortense Bioy.
Exposure to alcohol does not explicitly feature in the SFDR. “The exclusion of alcohol has its roots in the early stages of ‘ethical investments’ developed by the Quaker and the Methodists [back in the 18th century],” says Antje Schneeweiß, managing director of the working group of church investors in the German Protestant Church.
Schneeweiß, who was a rapporteur on the EU advisory body tasked with building a social taxonomy, added that this approach “has not been taken up widely on the [European] continent”.
Whether or not Article 8 funds should hold alcohol stocks at all remains open for debate.
“This is a case of fund managers using the greater flexibility afforded by Article 8 funds to diversify their portfolios during difficult market conditions,” says Montanaro Asset Management head of sustainable investment Ed Heaven.
“But investors should expect fund managers to stick to their ethical beliefs when it comes to investing,” he continues. “We saw U-turns with defence companies in the wake of Ukraine. Now alcohol? What next? It makes it very difficult for investors who want to invest ethically.”