Over the past 10 years, vice was virtuous for returns if you invested in guns, sex, meat, gambling and booze, all of which outperformed the stock market on average.

That guns are smoking stocks is not surprising, given that military spending, led by the U.S., has been on the rise for the past decade, and given the tragic frequency of mass shootings, which tend to boost sales as gun owners rush to stock up in fear that their right to bear arms will be curtailed.

MindGeek, based in Montreal, has cornered a huge chunk of the pornography market, but it is privately held, so no peeking for public investors. What is left over for public investors are a few piddly stocks that make up 0.02% of the total stock market, but they are grinding out above-market returns.

Owning gambling stocks has been a good bet for the past 10 years, thanks to a booming economy and casino operators expanding in Asia, but it may not pay to “own the house” when the economy hits a downturn.

Plant protein options like Beyond Meat are bursting onto the scene but have yet to take a bite out of surging demand for meat as Asia’s middle class grows. There could be some indigestion for the meat industry as animal welfare and health concerns propel a growing wave of flexitarianism and veganism around the world (which there is now an ETF for, by the way: VEGN is now listed on the NYSE).

Vice was not so nice for returns if you got stuck holding a bag full of companies on the wrong side of the law, human rights or the low-carbon economic transition.

While he is not a tobacco investor himself anymore, Warren Buffett once famously said, “I’ll tell you why I like the cigarette business. It costs a penny to make. Sell it for a dollar. It’s addictive. And there’s fantastic brand loyalty.” But as anti-smoking regulations continue to tighten, tobacco must now share the air with pot and vaping.

Prisons are a captive market, but for-profit prison stocks are getting booked for underperformance in the wake of a backlash from pictures of kids in cages at GEO Group that have been beamed around the world.

Crime has not paid for investors in the 100 companies with the worst records for breaking the law, which have acted as a ball and chain on their returns.

What used to be known as “black gold” is increasingly the source of red in investor portfolios, as the fossil-fuel growth story comes to an end more quickly than almost anyone predicted. While short-term geopolitical events could produce a rally for this sector, the big money is writing off those without a credible plan to transition to the low-carbon economy.

Just four companies dominate the global market for genetically modified seeds and pesticides. Bayer became the biggest company in the space when it swallowed Monsanto whole in 2018. Since then it has had some growing pains, under a heap of lawsuits related to allegations that the company’s glyphosate-based herbicides cause cancer.

Nuclear reactors create energy by splitting atoms, but they have caused many stockholders to split their hairs on account of their tendency to be delivered late and over-budget. Maybe the much-hyped next generation of nuclear reactors will have better luck.

The companies with the worst records for damaging people’s health, propriety, the environment and human rights have turned out to be wronging investors a lot, too, in terms of forgone returns.

The red-flag theme that has delivered the clearest cut to returns, as the Lorax may have predicted, is severe deforestation, where the worst-offending companies have seen their value axed by over 7% a year for the past 10 years.

How would it have worked out for an investor who went all-in on red-flag stocks?

Not so good. A total red-flag portfolio consisting of stocks across all 21 themes would have generated a 10-year annualized return of 3.6%, or less than half the 9.2% posted by the MSCI ACWI, a commonly used stock market benchmark, or the 9.1% tally of the Clean200, the 200 companies that earn the most revenue from providing environmental and social solutions.

As the next 10 years will likely be different from the last 10 years, perhaps the more important takeaway is that the “baddies” as a group make up a relatively small portion (13%) of the stock market.

So investors can decide which red flags they want to keep out of their portfolios without losing much in terms of diversification.

F1. The list of product/conduct red-flag companies was created by using various reports and databases to determine the “worst-in-class” companies for various indicators. The sources for each indicator are as follows: access-to-nutrition laggards – Access to Nutrition Initiative; blocking climate policy – InfluenceMap; civilian firearms – NZ Super Fund; controversial weapons – Norges Bank Investment Management (NBIM), NZ Super Fund; conventional weapons – Stockholm International Peace Research Institute; deforestation – Chain Reaction Research; farm-animal welfare – Business Benchmark on Farm Animal Welfare; for-profit prisons – American Friends Service Committee; gross corruption violations – NBIM; illegal activity – Corporate Knights Database; severe environmental damage – NBIM; severe human rights violations – NBIM; thermal coal – NBIM; tobacco – NBIM; adult entertainment – Motley Fool, Wespath; alcohol – S&P Capital IQ Industry Classification; energy (fossil fuels) – S&P Capital IQ Industry Classification; gambling – S&P Capital IQ Industry Classification; GMO pesticides – United States Department of Agriculture; industrial meat – Corporate Knights Database; nuclear energy – MVIS Indices.

F2. Total 10-year annualized USD returns for each red-flag category were calculated using S&P Capital IQ. Securities for each red-flag category are weighted according to market capitalization and rebalanced semi-annually. The CK Global 100 Index category was calculated separately by Solactive.

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The Corporate Knights Dark Red Flag Database consists of more than 2,500 companies from developed and emerging economies that have been identified as so-called ‘red flag companies’ due to their involvement in ethically or environmentally questionable industries and/or practices. These companies have been identified through a rigorous process including theme selection, source reliability analysis, and company identification processes. The list is updated monthly to reflect changes in source material. Sources include methodologically-sound reports by non-profits, bottom-up research by Corporate Knights, and the public and derived exclusions of two significant funds (Norges Bank Investment Management and NZ Super Fund).

The dark red flag themes are as following: Access to medicine laggards; Access to nutrition laggards; Adult entertainment; Blocking climate policy; Cement carbon laggards; Civilian firearms; Controversial weapons; Conventional weapons; Deforestation & Palm oil laggards; Energy (Fossil Fuels); Farm animal welfare laggards; For-profit prisons; Gambling; Gross corruption violations; Harmful pesticides; Illegal activity; Oil sands laggards; Severe environmental damage; Severe human rights violations; Thermal coal; and Tobacco.

In addition to the dark red flags, Corporate Knights also maintains a database of “light red flag” companies for the following themes: Alcohol; Blocking climate resolutions; Financing misleading media; Industrial meat; and Nuclear energy.

Please e-mail research@corporateknights.com for more information.

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What would it look like if the restrictions applied to lessen tobacco use were applied to GHG-emitting products, to reduce our carbon emissions? Think restrictions on advertising, promotion and lobbying, as well as public education, warning labels and restrictions on use.

In December, ClientEarth, a non-profit UK-based environmental law group, started calling for a ban on advertisements from fossil fuel companies. As we’ve seen with cigarettes, effective public policy can help to reduce demand for harmful products, with minimal cost or interference with the rights of individual Canadians. In a world awash with fossil fuels, not encouraging demand could be one key to effective climate action.

The Tobacco Epidemic

While researchers knew in the 1940s and ’50s that smoking causes lung cancer, smoking remained ubiquitous for decades, including in aircraft, restaurants, workplaces and bars. Even after public knowledge of smoking’s deadly health impacts became widespread, tobacco advertising was effective in recruiting new generations of young smokers and in normalizing smoking as a central part of North American society, with the result that tens of millions of North Americans have died of smoking-related illnesses since the release of the U.S. surgeon general’s 1964 report definitively connecting smoking with lung cancer.

In recent decades, increasingly strict tobacco regulation has been effective in reducing the prevalence of smoking and saving tens of millions of lives. Today, Canada regulates every aspect of the manufacture, sale, labelling and promotion of tobacco products and taxes them heavily, as part of the federal and provincial governments’ strategies to protect the health of Canadians from tobacco-related harm. As a result, smoking rates in Canadians aged 15 and older have fallen from roughly 50% in 1965 to 15% in 2017.

Lessons for Climate Policy

A number of industries currently spend tens of billions of dollars each year directly or indirectly promoting ever-greater consumption of GHG-emitting goods and services. The auto industry spent $35.5 billion in 2018 across 14 key markets, with $18 billion in the U.S. alone. The fact that Canadians drive the dirtiest, highest-GHG-emitting fleet of vehicles on the planet, according to the International Energy Agency, is a testament to the effectiveness of the auto industry’s promotion of SUVs and pickup trucks. (Ford’s F-Series pickup truck has been Canada’s top-selling vehicle 11 years in a row.) Similarly, the growth in GHG emissions from commercial air travel, up 32% from 2013 to 2018, is fuelled by massive travel industry advertising – worth more than $20 billion in the U.S. alone in 2019.

If we’re to learn anything from tobacco regulation and if governments are serious about curbing the worst impacts of climate change, they should restrict the advertising, promotion and sponsorship of GHG-heavy goods and services. While we’re tackling the issue, consumers should also be warned about the emissions impacts of their purchases through notices and warning labels on gas pumps, gas bills, airline tickets, automobile and appliance stickers, and other communications (similar to how the state of California posts warnings about the presence of carcinogens). We give consumers access to nutrition labels so they can make informed choices about the foods they purchase; the same consumer right-to-know should apply to embedded GHG emissions, as well as those that would arise when using a potential purchase.

The WHO Framework Convention on Tobacco Control, to which 181 countries (including Canada and the U.S.) are parties or signatories, provides an excellent model for new domestic and international rules to reduce demand, and also to reduce the political influence of industries that profit from increasing GHG emissions.

The climate crisis poses a clear existential threat to human civilization. The UN Environmental Programme’s 2019 Emissions Gap Report states that we need to reduce GHG emissions by 7.6% per year, starting in 2020, and we need to achieve net-zero GHG emissions by 2050 if we are to avoid ever more dangerous forms of climate disruption. Despite knowing of this problem for decades, our past and current policies have proven largely ineffective at reducing GHG emissions.

Greta Thunberg is correct: we have failed her generation. The rules, as she has said, have to be changed to achieve the dramatic reductions in GHG emissions mandated by the world’s leading climate scientists. Repurposed tobacco regulations might just help to lead the way.

Richard Corley’s interest in climate policy is informed by his background and work in engineering, law and clean technologies.

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