5 Top Fund Managers Back Tobacco Stocks

Despite regulation on tobacco products putting profits at risk, tobacco stocks deliver positive returns and top fund managers in the UK still favour them

Karen Kwok 3 June, 2016 | 1:02PM
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The introduction of standardised packaging on tobacco products has come in force in the UK and France in an effort to reduce demand for tobacco products – potentially risking the profit margins of tobacco companies. However, five of the top UK equity income fund managers in the UK clearly do not perceive the new policy as a threat to dividends; they own tobacco companies in their top 10 holdings, according to data from Morningstar Direct.

Plain packaging of tobacco products began in the UK and France on May 20, following Australia’s move in 2012. It restricts the use of logos, colours, brand images and promotional information on packaging other than brand and product names displayed in a standard colour and font style. According to World Health Organization’s Director-General Dr Margaret Chan, this measure can reduce the attractiveness of tobacco products.

“Plain packaging kills the glamour, which is appropriate for a product that kills people,” says Chan, “It restricts tobacco advertising and promotion. It limits misleading packaging and labelling. And it increases the effectiveness of health warnings.”

AXA Sells Tobacco Industry Assets

AXA Group the world leading insurance and asset management company, last month announced plans to sell its tobacco industry assets, valued at approximately €1.8 billion.

“It makes no sense for us to continue our investments within the tobacco industry,” said Thomas Buberl, deputy CEO and incoming CEO of AXA, “With this divestment from tobacco, we are doing our share to support the efforts of governments around the world. This decision has a cost for us, but the case for divestment is clear: the human cost of tobacco is tragic; its economic cost is huge.”

Tobacco: Highly Successful Sin Stocks

Despite recent moves posing risks to the industry, tobacco companies in the UK consistently deliver impressive returns: British American Tobacco (BATS) gains 12.4% year to date while Imperial Brands (IMB) has generated 5.2% return year to date.

British American Tobacco has a stronger brand loyalty than Imperial Brands, however when plain packaging legislation spreads, Imperial Brands may be the manufacturer best positioned to benefit, according to Morningstar analysts. Both companies’ dividends yield more than 3%. In addition, in the long term and as developing markets mature, analysts expect significant growth in the British American Tobacco's dividend.

Tobacco stocks are good examples of successful “sin stocks”, meaning the sort of companies that would not pass the stock screening of an ethical fund. In the past 20 years tobacco stocks faced several significant industrial threats however they continue to pay out inflation-busting dividends. Other sectors of sin stocks are alcohol, animal testing, tobacco, oil and armament firms.

Woodford Builds Up Tobacco Bias

With such outperformance in tobacco stocks, some of the UK’s largest and most successful funds own them in their portfolios, including Neil Woodford in his Bronze Rated, CF Woodford Equity Income fund.

Woodford has long favoured tobacco stocks, and as far back as 2000, they accounted for around 20% of his previously managed Invesco Perpetual funds, according to Morningstar fund analysts. Woodford’s long-term track record that encompasses numerous market cycles is strong. The fund set with the objective of generating a positive capital return in the long term and growing the income while offering capital preservation. The fund delivered positive returns at 15.9% in 2015.

Currently Woodford owns three tobacco companies in his top 10 holdings: Imperial Brands is the largest holding of Woodford’s fund at 7.2% and British American Tobacco makes up 5.9% of the fund. Another US tobacco company Reynolds American (RAI) also makes up 3.8% of the fund, ranking as the 7th holdings in the fund.

5 Top UK Funds Own Tobacco Stocks

For investors who wish to have exposure to tobacco industry without directly investing in them, there are four other top UK funds to be considered in addition to Woodford’s fund.

British American Tobacco makes up 3.9% of the Silver Rated fund, Royal London UK Equity Income. The fund is managed by Martin Cholwill, a “seasoned manager” with more than 30 years’ experience. It has generated 7.7% three years annualised return and five years annualised return at 10.7%.

Temple Bar (TMPL), a Gold Rated investment trust also has 4.1% holdings of British American Tobacco. The trust is trading at a 6.3% discount, and it has 6.1% five-year annualised return. The trust is managed by an experienced manager Alastair Mundy.

Another UK tobacco stock Imperial Brands makes up 3.4% of Artemis Income, a Gold Rated fund and it dominates 2.8% of the portfolio in Standard Life Investments UK Equity High Income, a Bronze Rated fund. The fund is managed by Karen Robertson and it generates 7% five years annualised return.

Artemis Income features a “distinguished pairing” in Adrian Frost and Adrian Gosden, and it has 8% five years annualised return and 6.3% 10 years annualised return. The two managers share an impressive amount of industry experience, most of which has been gained through the management of UK equity income strategies, Morningstar analyst Simon Dorricott says. He says the fund remains a good choice in the UK equity income sector.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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About Author

Karen Kwok

Karen Kwok  is a Reporter for Morningstar.co.uk