Mutual funds that own gun stocks need to divest or engage

Jon Hale
Jon Hale
Feb 19, 2018 · 5 min read

After the tragic mass shooting in Florida last week and the many that have come before it, now is the time for mutual-fund companies that profit off of their investments in gun makers to be part of the growing efforts to address the epidemic of gun violence and mass shootings in this country, rather than remain silent bystanders.

Mutual funds are among the largest owners of the four public companies that manufacture guns and ammunition in the U.S., including American Outdoor Brands (AOB), the firm that made the AR-15 used in the massacre of 17 high-school students last week in Parkland, Florida.

The Vanguard Group, by itself, owns 8% of AOB shares making it the gun maker’s largest institutional shareholder. Mutual funds own approximately 37% of AOB shares, according to Morningstar estimates based on publicly reported fund portfolios. Most of this exposure, like Vanguard’s, is in passive index funds and results from AOB being in small-company indexes those funds attempt to replicate. One active fund, though, Invesco Small Cap Value, by itself, owns nearly as much AOB as Vanguard owns in multiple funds.

One thing mutual funds could do is divest their holdings from gun makers. Leave it to the hedge funds to try to make money off them. But the mutual-fund companies that are making enormous profits from index investing simply say their hands are tied — they can’t divest because they are “required” to replicate a third-party index.

Here’s how BlackRock tried to wash its hands of the issue in a statement to CNBC last week, “As a significant provider of index-based investments, we are required to replicate the holdings of particular indices. Third-party providers determine which companies are included in these indices.”

That’s a total cop-out and not even completely true. First, nowhere in the typical index-fund prospectus does it say a fund is required to replicate exactly the holdings of an index. In fact, most small-cap index funds use sampling techniques and do not invest in every company in the indexes they are tracking.

Second, to make its intentions all the more explicit, a BlackRock or a Vanguard could simply send a notice to shareholders that they are no longer investing in gun stocks in their index portfolios. Because of the sophisticated optimization techniques that passive managers already use, this would have no impact on the risk-return characteristics of the funds. Third, as some of the world’s largest asset managers, fund companies could require their third-party index providers to remove gun stocks.

If the fund companies refuse to divest for these (supposedly) technical reasons, they still cannot avoid the issue because there is something else they can do that could be more effective than divestment. As major shareholders, they can actively engage with the gun companies urging them to stop standing in the way of the consideration of common-sense gun regulations, to stop making certain types of guns, ammunition, and accessories, and to tighten its distribution oversight to ensure that retailers selling its products follow background checks and other applicable regulations.

If the gun maker refused, investors could file a shareholder resolution and put it to a shareholder vote. While a shareholder resolution might not sway an obstinate company, it would signal the company’s stance publicly in a way that would further inform public discussion.

BlackRock, Vanguard, and State Street have all ramped up their engagement activities in recent years. The theory behind these efforts is that, because so many of their assets are in index funds, they are long-term permanent investors who have a stake in maintaining and strengthening the broader systems within which investment occurs, because over the long run, healthy systems will create the conditions for healthy investment returns. Thus, their engagement activities are oriented towards systemic issues that both affect companies and that companies could affect through their actions.

Gun violence in the U.S. clearly fits that theory of engagement, yet I’ve seen no evidence that any major mutual-fund company has engaged with the gun makers in their portfolios. In Vanguard’s case, it is the largest shareholder in three of the four public gun manufacturers and the second largest, behind Fidelity in the fourth. If they have so engaged, it’s past time for the fund companies that have done so to tell their investors about it.

Here is what BlackRock CEO Larry Fink said in his letter to company CEOs last month:

“Society is demanding that companies, both public and private, serve a social purpose.”

“Companies must benefit all of their stakeholders, including shareholders, employees, customers, and the community in which they operate.”

“To prosper over time, every company must not only deliver financial performance, but also show how it makes a positive contribution to society.”

Surely Fink would agree that his advice applies to fund companies as well as the firms in which they invest. Mutual-fund companies have a responsibility to their investors, to themselves and to society to help address the problem of gun violence, and in the process, demonstrate that they too have a “sense of purpose”.

— — — -

Here is a list of the largest institutional shareholders of each of the four public companies in the U.S. that make guns and ammunition. AOL, RGR, and VSTO all make versions of the AR-15.

Source: Morningstar Direct
Source: Morningstar Direct
Source: Morningstar Direct
Source: Morningtar Direct; updated 2/28/18

The ESG Advisor

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Jon Hale

Written by

Jon Hale

Global Head, Sustainable Investing Research, Morningstar. Views expressed here may not reflect those of Morningstar Research Services LLC. or its affilliates.

The ESG Advisor

Incorporating sustainability and impact into your investments

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