A U.S. high school student-led protest is prompting discussions over reforms in the US$3-trillion exchange-traded fund business, building on momentum that has already created opportunities for investors to buy gun-free index-linked products. A bigger question is whether there is a push to rethink the components of the bigger indexes themselves, which are a core holding of millions of institutional and ordinary investors alike.
Gun reform activist David Hogg has decided to take on Wall Street and heavyweight investment managers by calling for the boycott of Vanguard and BlackRock, two of the world’s biggest investors and owners of publicly traded firearms manufacturing from makers like Sturm Ruger (RGR: NYSE) and American Outdoor Brands (AOBC: NASDAQ).
Hogg, who just turned 18, survived a horrific mass shooting at his Parkland, Fl. high school two months ago. He is campaigning to take Vanguard and BlackRock to task for gun-exposure in their ETFs and actively managed funds.
In response, Vanguard and BlackRock have indicated they are reviewing their holdings of the gun manufacturers shares. Blackrock had already announced it would issue new actively managed ETF funds that would exclude gun stocks. But the jury is still out about whether these gun changes will ever be made to BlackRock and Vanguard’s broader indexes. U.S. broad market indexes, especially those linked to the S&P 500 Composite, are popular with Canadian investors and BlackRock and Vanguard have the leading ETF products.
“I don’t see Vanguard and BlackRock dropping the big gun companies from their broad index ETFs, where the goal is to include all sectors and companies,” says Dan Hallett, director of asset management for HighView Financial Group.
“ETFs that don’t include guns already exist for investors. But if guns become a large enough social movement, then index holdings in these broader ETFs could also be affected, mainly because holdings will decrease in proportion to the portfolio size if gun activists are effective in decreasing retail demand for guns.”
Taking aim at gun stocks
The trend is not new. An April 2018 research paper from Sustainalytics titled, “Assault weapons: Assessing exposure to the firearms trade” co-written by Martin Vezer and Doug Morrow, found that Norway’s $1.2 trillion U.S. sovereign wealth fund had recently sold its holdings in the three largest U.S. firearm producers, a decision its CEO suggested was based on investment (rather than ethical) issues. Some state pension funds are considering similar actions.
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Where does that leave Vanguard and BlackRock? Well, right now, BlackRock already excludes gun-makers from all of its actively managed funds and from its iShares MSCI KLD 400 Social ETF (DSI), the largest socially responsible index ETF. Vanguard, too, excludes gun-makers from its FTSE Social Index Fund. But for many gun activists that isn’t enough.
Gun stocks: A small weighting but a pervasive one
The percentage of fund assets in gun stocks is small—often less than 2% of assets in actively managed funds. But with the reality of mass shootings in the U.S., and particularly the mass shooting at a high school in Parkland, this could prove to be an inflection point for gun control, with companies and investors taking up the cause while gun manufacturers begin to feel the impact of the socially responsible philosophy of investing with your conscience.
But if it’s the exposure to these stocks in your portfolio that you’re interested in, then you likely have reason to be concerned. In fact, you may be surprised to learn that the Sustainalytics report found that global investment exposure to the firearms trade may be more pervasive than some investors realize. It found that 24% of all ETFs and 15% of all mutual funds hold at least one of the 40 public companies involved in the global firearms industry. And most of the 40 publicly traded companies in the firearms industry (70%) cater to the civilian market (as distinct from the military/law enforcement market.)
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So what’s a concerned investor to do?
First, realize that investment opinions regarding Environmental, Social and Governmental (ESG) funds are across the map. For instance, Eric Kirzner, Professor of Finance for Rotman School of Management at the University of Toronto wrote one of the early articles on the emerging ethical fund sector back in 1986 and his view is clear. “Look, if you feel strongly and don’t want to hold any companies that work with guns, that’s wonderful,” says Kirzner. “It’s probably going to cost you [to invest around the major indexes] but guns have not been a huge part of the index, so the cost could be small.”
The reason, says Kirzner, is that funds that have exclusion stock screens (meaning they don’t invest in a particular sector, such as tobacco, alcohol, guns, etc.) tend to cost more in fees than non-exclusionary ones. So when you factor in higher management fees and the possibility of lower returns than broader-based index funds, investors could be giving up about 1% in average annual investment returns.
“If it makes you sleep at night, then ESG funds and those that exclude guns could be worth it,” says Kirzner. “And there is some growing evidence that the exclusionary ESG funds might outperform the inclusionary funds over certain time periods.” So the news on investment returns isn’t all bad—and certainly not conclusive yet. Still, Kirzner stresses that if you really want to have an impact on guns, “divest yourself of the actual gun stocks. That’s more effective to a company’s bottom line.”
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What about returns on funds that avoid guns?
If you’re interested solely in investment returns for funds minus guns, the Sustainalytics research found that total returns of the five companies in the FTSE Global All Cap index that produce or sell assault weapons to civilian customers—including Sturm Ruger, American Outdoor, Vista Outdoor and Dick’s Sporting Goods—delivered three-year returns that trailed the market by 15 to 17 percentage points, showing that “the financial performance of firearms companies is far from bulletproof. While these companies have varying degrees of percentage revenue exposure to assault weapons, their average three-year total return was -8.2%, which is 28.8 points below the benchmark.”
What else can you do?
Tim Nash, founder of GoodInvesting.com, a website that helps investors “put their money where their heart is”, believes it’s the stigma and denormalization of some company holdings that has the most social impact. Guns, he argues for instance, become like toxic assets that create a stigma that affects the company brand. “I would argue this stigmatization has the largest impact, and then as big investors make these investments, that too has an impact,” says Nash.
So does simply avoiding buying guns altogether, since as demand goes down, these gun companies lose money and their CEOs have to come up with new ways for the company to be profitable—and keep shareholders happy. “It effectively creates negative goodwill,” says Nash. “It will become harder for these companies to raise money and get acquired by other companies. Employees won’t want to work there so wages and employee costs will have to be higher to attract them. All this will cause these companies to underperform and that instigates action and change.”
Still, financial philosophies matter in good investing. For Dan Hallett, the issue is really a much more philosophical one. “When it comes to eliminating guns—or anything else—from a broad-based index, there’s a collision between finance theory and social responsibility,” says Hallett. “Just getting a piece of every market is a good investment strategy.”
But Hallett also goes on to explain that the ESG investing movement is a valid theory. “Companies with good governance and human resource practices, have healthier corporate cultures and better investment performance in the long run. And strong corporate performance should correlate with good investment returns.”
The bottom line
If you believe avoiding guns is the socially responsible thing to do, then have a talk with your advisor about delving into some of your portfolio holdings and examining what percentage of the total are invested in gun products or gun retailers. There are alternatives.
“Numerous Canadian responsible investment funds have been screening out weapons for decades,” notes Dustyn Lanz, CEO of the Responsible Investment Association in Toronto. Some of those gun-free investment products are offered by companies such as OceanRock Investment Solutions, iA Clarington, RBC Royal Bank, and Desjardins to name a few. As well, Lanz adds that AGF and Greenchip offer thematic funds focused on sustainability issues which naturally don’t invest in weapons manufacturers.
Ethically responsible funds have been available for years. Interest in them is just starting to gain more momentum. If you’re concerned about socially responsible investing, and gun investing in particular, invest the time to do your research and assess your holdings.