In the aftermath of the Parkland mass shooting last year, many investors expressed concern about owning gun manufacturers in their mutual fund holdings, which led me to write this piece on finding gun stocks in fund portfolios.
Since then, we've had on ongoing string of mass shootings in Santa Fe, TX; Pittsburgh, PA; Thousand Oaks, CA; Aurora, IL; and Virginia Beach, VA. And then in the space of eight days: Gilroy, CA; El Paso, TX; and Dayton, Ohio.
As the epidemic of gun violence in the United States continues, pressure is building for action to be taken to address it. If you are concerned about gun violence and are a fund investor, you may want to know whether you are invested in gun stocks. Or not: It's a reasonable position to be concerned about the issue and want to see something done to address it, but not to be worried about guns in the context of your investments. That view may depend on the extent of your exposure to guns.
Here are some steps you can take to analyze your exposure to gun makers and, if warranted, to take action to mitigate that exposure or eliminate it altogether.
What public companies in the U.S. manufacture guns?
A year ago, there were three. Today there are two: American Outdoor BrandsAOBC and Sturm RugerRGR. With market capitalizations of $465 million and $765 million, respectively, the two are considered small-cap stocks. In July, Vista OutdoorVSTO sold off its Savage Arms gun manufacturing division to private buyers, although Vista Outdoor remains in the ammunition manufacturing business.
Do you own either gun maker in your fund portfolios?
If you have an investment in a fund that includes small U.S. companies in its portfolio, the answer is probably yes. That's because about two out of every three dollars invested in U.S. small-cap stock funds are in indexed portfolios, which own the entire market of small-cap stocks. That includes American Outdoor Brands and Sturm Ruger. In addition to small-cap index funds, those that are “total market” or “extended market” funds also include the two gun makers.
If you get small-cap exposure via an actively managed fund, chances are you are not exposed to either stock. Out of 500 actively managed funds in the small-blend, small-growth, and small-value Morningstar Categories, only 24 have positions in American Outdoor Brands and 32 in Sturm Ruger.
Exhibit 1 shows the mutual funds that hold the largest number of shares in American Outdoor Brands and Sturm Ruger. Even though Sturm Ruger is only a 0.3% position in iShares Core S&P Small-Cap ETF IJR, the fund is so large that a tiny position in a small company equates to the fund holding 6% of Sturm Ruger's outstanding stock.
If you do have exposure to either gun maker, is it material to your investment returns?
Not likely. If you hold a small-cap index fund, American Outdoor and Sturm Ruger take up only about 0.05% of assets combined, hardly enough to materially affect performance one way or another.
To illustrate, let's take a look at how these two stocks would have affected returns of the Vanguard Small-Cap Index fund over the last three years. The fund posted an 11.01% three-year annualized gain through July 2019. This was a terrible period for both AOBC and RGR, which lost 31.08% and 3.86% on an annualized basis, respectively. By my estimate, those losses reduced the index fund's returns by barely 0.01% on an annualized basis.
Given the de minimus impact on investment returns, most small-cap index investors can rest easy knowing they are not invested in guns to a degree that it affects their investment return.
If you are one of the few who are invested in an actively managed fund that has positions in AOBC or RGR, the stocks could have been a more noticeable drag on recent performance, depending on the size of the positions and when your portfolio manager added the stocks to the portfolio. But even in this subset of funds, average position sizes are small: 0.1% for AOBC and 0.49% for RGR.
With so little exposure to guns in my portfolio, is it worth it to take steps to exclude guns altogether?
That's a question for each investor to answer. It may be enough to know that an exceedingly small portion of your investment return comes from your indirect investment in gun makers via funds. But if you want to avoid guns completely, on principle, it's not hard to invest that way.
You can do this by investing in a fund that avoids guns as a matter of investment policy. I've listed several of these in Exhibit 2.
These funds exclude producers and retailers of civilian firearms and also have a broader focus on investing in companies that manage their environmental, social, and corporate governance risks well.
Index investors might consider iShares MSCI USA Small-Cap ESG Optimized ETFESML. Launched in the aftermath of the Parkland mass shooting last year, the fund avoids guns, tobacco, controversial weapons, and optimizes the rest of the portfolio to maximize exposure to companies with higher environmental, social, and governance ratings, while broadly maintaining the risk and return characteristics of a conventional small-cap index. It has a competitive expense ratio of 0.17%.
Is my asset manager engaging with gun makers and other companies it owns?
If you own a fund from Vanguard, BlackRock (including iShares), American Funds, or any large asset manager, regardless of whether they limit investment in guns, you should expect them to be actively engaging with the companies they own about issues that may affect long-term shareholder value.
Take Walmart WMT, for example. Unfortunately, a Walmart store in El Paso was the site of one of last week's mass shootings. As the largest retailer of guns in the U.S., Walmart is also the large-cap stock most directly associated with guns. Walmart's current weight in the S&P 500 is 0.63% and it is often included in the portfolios of active managers.
In an open letter to Walmart's CEO this week, New York Times business columnist Andrew Ross Sorkin argued that, as the country's largest retailer and largest seller of guns, Walmart's CEO has “greater sway over the entire ecosystem that controls gun sales in the United States than any other individual in corporate America.”
Sorkin urged Walmart to use its leverage to pressure gun makers to incorporate gun safety technology, to develop “enhanced background checks and sales processes and pressure gun makers to sell only to retailers that follow these measures.” He also suggests that Walmart use its influence to get banks and credit card systems to track gun sales, and generally to assert corporate leadership on an issue that politicians have been unable to address.
This is exactly the type of conversation your asset manager could be having with Walmart and other companies it holds. The giant asset managers who manage index funds, like BlackRock and Vanguard, not only are among the largest shareholders of most public companies--as long-term permanent investors, they also have a stake in maintaining and strengthening the broader social systems within which they invest.
Over the long run, their investors stand to benefit because healthy systems create the conditions for better investment returns. Thus, their engagement activities should include systemic issues that affect subject companies materially and that the companies can play a role in helping address more broadly. The misuse of guns has spillover costs on many other companies that they hold in their portfolios, as well as on society at large.
Significant engagement with gun makers, gun retailers, and banks and credit card companies that finance gun purchases at this point should be an obligation.
To find out the extent to which the asset management firms that run your funds are engaging with companies on guns and other issues, take a look at their shareholder engagement reports. If you can't find one, that's an indicator they may not be doing much.