Ask the Manager: Pieter Vorster on the NICO ETF and the Nicotine Transition

The global tobacco industry is funding its own disruption, with the largest incumbents channelling cigarette cash flows into heated tobacco, nicotine pouches, vapor and snus. Hexis Capital Management launched the Hexis Active Nicotine Engagement ETF

in May 2026 to invest in that shift and to press boards to accelerate it. In this edition of Ask the Manager, founder and Chief Executive Pieter Vorster explains why the firm favours engagement over exclusion, how its Nicotine Transition Score drives portfolio construction, how the stewardship program is governed, and how advisers might think about sizing a single-industry allocation.

Let’s start at the sector level — how would you characterize the current state of the global tobacco and nicotine industry, and what’s driving the shift toward reduced-risk products?

It is an industry disrupting itself. Combustible cigarettes remain one of the most cash-generative categories in the world, and the incumbents are using that cash to fund the products designed to replace them: heated tobacco, nicotine pouches, vapor and snus. That is rare in public markets. Usually the disruptor arrives from outside; here the disruption is being financed from inside.

The numbers show how far it has gone. Philip Morris International took 2.7% of its net revenue from smoke-free products in 2016 and 41.5% in 2025, with an ambition of more than two thirds by 2030. In Japan, non-combustible products went from 0.3% of nicotine volume to roughly 46% in a decade, and by late 2025 more than half of all nicotine volume there was smoke-free. Globally, the non-combustible share of nicotine volume has roughly doubled in ten years while total nicotine volume fell slightly.

Three things are driving it. First, consumers switch when they are allowed to and the products are good enough; Japan is a good example of that. Second, regulators have begun to regulate by relative risk. The FDA granted modified-risk orders to IQOS in 2020 and to ZYN in June 2026, the agency’s strongest statement short of approving a medicine. Third, the market already pays for progress: companies further through the transition trade on materially higher multiples than those that are behind, so the industry is incentivized to get behind this trend.

A caveat is that the transition is uneven because regimes differ widely, and several large markets ban reduced-risk products while cigarettes stay on sale. Inhaling smoke is what causes tobacco-related diseases, so these new products reduce risk by removing the smoke. But they still contain nicotine, which is addictive, which can make regulators cautious.

Many investors who care about public health outcomes have historically excluded tobacco entirely. Why do you believe engagement, rather than exclusion, is the more effective lever for change — and why now?

Because exclusion changes the owner, not the company. When you sell, your vote leaves with the shares. We can’t know whether the buyer will press for change, but the seller certainly can’t.

Divestment is meant to work by raising a company’s cost of capital. But cigarettes need almost no outside capital; the factories and brands were built decades ago and the legacy business funds itself. So divestment makes the transition harder to finance, not the cigarettes.

Tobacco is the most-excluded sector in finance, with more than $19 trillion of assets behind the Tobacco-Free Finance Pledge across 219 institutions in 21 countries. The largest US public pension fund, CalPERS, sold out of tobacco a quarter of a century ago; its own consultant, Wilshire, now puts the cumulative cost at about $6.16 billion, or 1.1% of the fund, and the board voted to keep the exclusion in 2016, 2019 and 2021. We are not saying cost settles an ethical question; it doesn’t. But CalPERS itself argues that fossil-fuel divestment “is not an effective solution” because it merely transfers shares to owners who will not press for change. We apply the same logic to nicotine.

Engagement means you own, and you press for specific, dated change: a board-owned commitment, capital allocated to it, pay linked to it. But it isn’t a silver bullet – companies can say no, and change takes years.

Why now? Because the target has moved. Exclusion screens were written for companies whose primary business was making and selling cigarettes. At 41.5% smoke-free and rising, that description is starting to stop fitting the industry leader. Boards are now setting harm-reduction ambitions, but most of those ambitions still lack what their climate commitments already have: a date, a quantified target and a long-horizon pay link. That gap is measurable, and closing it is exactly what a shareholder can ask for.

What was the specific gap in the market that led Hexis to launch NICO, and how does it differ from existing tobacco-sector ETFs or broad “sin stock” strategies?

Most investors have approached this industry in one of two ways: own it passively, through broad index funds, or exclude it altogether. Plenty of active investors do hold tobacco stocks directly, and some hold them in size. But very few of those active owners engage the companies on the transition itself, and none, to our knowledge, had built a vehicle that did so and made it available to advisers and their clients in a single trade. Passive ownership means market-cap weights, no view on which companies are actually transitioning and nobody pressing the boards. Exclusion means giving up the return, the income and the vote. And a direct holding in one or two of the large names is a single-stock bet, usually with no engagement attached. The gap was a third path: own the transition actively, across the global universe, and push it.

NICO is built to do that. It is an actively-managed ETF, listed on NYSE Arca in May 2026, holding companies moving from cigarettes to reduced-risk products. Every holding must already generate revenue from reduced-risk products and have a strategy to grow that share. Positions are set by our Nicotine Transition Score feeding a fundamental valuation model, not by market capitalisation. And as an owner we vote our shares and put a specific harm-reduction request to every board, with independent oversight of how we do it.

That is quite different from a “sin stock” strategy. Those baskets group alcohol, gambling, weapons and tobacco on the premise that controversy is underpriced. We hold one industry, on the premise that the transition within it is mispriced and can be accelerated. NICO gives access in one trade to a global set that is hard for a US investor to buy directly, including Japan Tobacco, KT&G, Haypp and Scandinavian Tobacco Group, alongside the large incumbents, run by people who follow this sector full time.

We do not label it an ESG fund. It is an active engagement strategy. Where it touches sustainability is in outcomes: measurable harm-reduction commitments, an engagement program with independent oversight, and a public stewardship report. We think that is more meaningful than a label.

Can you explain how the Hexis Nicotine Transition Score (HNTS) works, and how it translates into portfolio construction and position sizing?

Most tobacco screens sort companies by what they sell today. HNTS is designed to measure where they are going, and the key word is executing: the score assesses what a company is doing, not what it says.

It has 27 indicators and 13 sub-indicators across three weighted components. Forty percent is where the company is today on reduced-risk products, chiefly the share of revenue they already represent. Thirty-five percent is its potential to capture reduced-risk growth: pipeline, innovation, geographic runway. Twenty-five percent is governance, engagement and sustainability: whether the board owns the transition and whether accountability and pay are aligned to it. About 40% of the score is AI-supported, including machine reading of patent filings, hiring-trend analysis and market-sentiment signals across the global universe, all under research-team supervision. AI supports our fundamental research; it does not replace it. The methodology has been independently reviewed by ACA Ethos, which concluded it provides a reasonable basis for assessing transition progress, and our independent Harm Reduction Stewardship Council reviews it too and has already pushed back on parts of it.

The current scoring cycle spans roughly 2 to 7 out of 10 across the eleven companies in the universe. A sector exclusion sees none of that dispersion.

On portfolio construction, the score feeds a three-stage discounted cash flow valuation. Years one to three use consensus estimates. Years four to ten adjust growth by the score and by the growth of the reduced-risk categories each company is exposed to. Position size then follows the gap between our value and the market price. So a high score is not automatically a buy, and a weak score with a wide discount can be. In practice the pure-play companies score highest and are our smallest positions, because they are small, less liquid and already expensive; the largest positions are incumbents where the gap between transition progress and price is widest.

The same score informs what we ask each board for. Where a company scores poorly, that tells us precisely what to raise. One framework, two uses.

How does the engagement program itself operate in practice — who leads it, how is it governed, and what does success look like?

It is led by Tim Youmans, who has led more than 1,200 engagements since 2018, previously as Executive Director of Engagement at Calvert and in building EOS North America at Federated Hermes. The program opened on 12 May 2026, the week after listing. Every holding was contacted within the first quarter; we vote every share we hold and publish a rationale whenever we vote against a board recommendation, as we have already done at annual meetings this year on auditor independence, overboarding and incentive plans.

Each company receives requests in two tiers. Tier one is similar for every company, although it reflects different degrees of progress at each: a board-owned harm-reduction commitment, with capital allocated to it. Tier two is one or two tailored requests drawn from the score: it could be research and capital spend on reduced-risk products, board accountability and pay, responsible marketing and youth access, lobbying, or disclosure. Progress is tracked against four milestones: objective raised; company engages substantively; company has a credible plan; substantive progress made. “Substantively” means discussing it seriously, not agreeing.

Governance sits outside the firm. The Harm Reduction Stewardship Council is chaired by Dr Derek Yach, the architect of the WHO Framework Convention on Tobacco Control, with Dr Peter Stanbury. It reviews the methodology and the engagement plan, and publishes its own annual statement. It is independent and advisory, and doesn’t have investment authority.

Take a company where climate has a dated target, a quantified goal and a share of the long-term incentive plan, while the harm reduction target has no date, is based on a growth rate rather than an absolute, and impacts the annual bonus only. Success is that board owning harm reduction on climate’s terms and naming the committee that holds responsibility. Three months in, we have named requests in dialogue with several holdings and two objectives at the substantive-engagement milestone. That is early-stage process, not a result. The test is the first annual Stewardship Report, in the first quarter of 2027, which will say what we asked for, at which company, and what happened, including where nothing happened. Then you can judge us.

The Fund is concentrated in a single industry group by design. How should advisers think about sizing an allocation to NICO within a broader portfolio?

NICO is non-diversified and single-industry, with roughly two thirds of the portfolio in its three largest holdings. So advisers should think about this as a satellite, not a core holding, sized so that a bad outcome in one of the largest positions is survivable.

Over fifty years US tobacco has had a lower correlation with the US equity market than almost any other equity exposure an adviser holds, about 0.44, but it has also been more volatile than the market in absolute terms, and its tracking error against the market has run at about 20% a year. Regulation can move in both directions, and the pace of transition varies by market. Those are the reasons this sector needs active management.

Within that, we see three ways the exposure is used. As a source of equity income that is not funded by writing calls, so participation in any re-rating is not capped. As a diversifier from what clients already own, given how differently the sector behaves from the broad market and from the large technology names in particular. And, perhaps most practically, as an alternative to a legacy single-stock position: many client portfolios still carry an Altria or a PMI holding inherited years ago. NICO replaces that with eleven companies across seven markets, continuous research, and a stewardship program.

We do not recommend an allocation percentage; that is the adviser’s judgement about the client.

Looking ahead, what should investors watch for — both in terms of industry transition milestones and Hexis’s own product roadmap?

On the industry, watch four things. First, the moment smoke-free passes half of revenue at the leader. PMI is at 41.5% with a stated ambition of more than two thirds by 2030; BAT targets more than half of revenue from smokeless products by 2035. When those lines are crossed, the definition of “tobacco company” that most exclusion policies rely on will start to seriously come into question, and allocators will have to decide what their policy was actually for. Second, whether the large markets that currently ban reduced-risk products while cigarettes stay on sale begin to move, and mirror developments seen in the markets like the US and Japan. Third, boards. The test we apply is whether harm reduction acquires what climate already has: a date, a quantified target and a long-horizon pay link. Any company that puts those three things in its annual report has changed the terms of the debate. Fourth, the information gap among investors themselves. When we polled US financial professionals on a live webcast in September, half described e-cigarettes as about as harmful as, or more harmful than, cigarettes. It was an indicative poll, not a scientific sample, but it matches what we hear in meetings. If the people pricing these companies do not believe the risk gap exists, the transition is being valued by people who do not believe in it. Closing that gap is part of our job.

On Hexis, everything we have described is published at hexis.capital. Our independent Harm Reduction Stewardship Council will publish its first annual statement. Our first Stewardship Report follows in the first quarter of 2027: what we asked for, at which company, how we voted, and what changed. The Nicotine Transition Score is re-run through the year, and the methodology will evolve with the Council’s input.

NICO is our first product, and our priority is to run it well and publish the evidence. That said, the approach behind it was not designed for one industry. It combines a transition score, fundamental valuation and structured engagement with independent oversight, and we believe it could be relevant to other consumer sectors where products carry recognised health concerns and where investors have tended to choose between passive ownership and exclusion. Tobacco is the natural starting point because the harm is undisputed, the alternative products already exist and the transition can be measured; food and alcohol are examples of sectors where similar questions of product reformulation, consumer health and corporate transparency are increasingly part of the investment discussion. Any future strategy would have to meet the same tests as NICO: a transition that can be measured company by company, and engagement objectives that are specific and dated.