Clients Want Out of Gun-Related Stocks? Here’s Some Advice
Morningstar's Jon Hale discusses how advisors can help clients understand their options.
The horror of the last week, with three mass shootings in eight days in the United States, has woken many investors to wonder about what’s in their portfolio. Do they own companies that manufacture or sell guns and ammunition/?
“Since Parkland [Stoneman Douglas High School, where 17 people were killed in a shooting on Feb. 14, 2018], we’ve had more advisors asking about how to find gun stocks in portfolios, because it’s not easy to ferret them out, and look for alternatives,” Jon Hale, global head of sustainable research at Morningstar, told ThinkAdvisor. “[It’s one reason] why environmental, social and governance funds keep building [assets] quarter after quarter.”
In a recent Morningstar paper, Gun Stocks in Fund Portfolios, Revisited, Hale explained how much gun-stock exposure investors may have through index investing. He dissected small-cap indexes to determine how to “take action to mitigate that exposure or eliminate it altogether.”
For example, today only two public U.S. companies, which would be considered small-cap holdings, manufacture guns, including assault weapons, in the United States. They are American Outdoor Brands (AOBC) and Sturm Ruger (RGR). RGR stock had been relatively stable around $56 until July 31, when it fell dramatically, landing at $42.78 by Aug. 9. Likewise, AOBC stock was at $9.64 on July 31, and fell to $8.28 by Aug. 9.
Chances are, said Hale, those who have investments in U.S. small-cap portfolios have some exposure to these gun manufacturers. “That’s because about two out of every three dollars invested in the U.S. small-cap stock funds are in indexed portfolios, which own the entire market of small-cap stocks,” he noted in his piece.
However, investors who get small-cap exposure via actively managed funds are different, and Hale says most likely not exposed to these gun stocks. He notes that of the 500 actively managed funds in the small-blend, small-growth and small-value Morningstar categories, only 24 have positions in AOBC while 32 have exposure in RGR.
Still, advisors should understand and be able to explain to clients that exposure to these companies probably won’t make much of a difference to their portfolio performance. It really is whether or not the investor wants any gun manufacturers in their portfolio.
For example, mutual funds that hold the largest number of shares in these companies have very little exposure. In the iShares Core S&P Small-Cap ETF (IJR), RGR is only 0.3%, which translates into the fund holding 6% of the company’s outstanding stock, Hale explains.
“To get to that [0.3% position] the fund is so large it has to buy that much of a small-cap stock,” Hale said.
To illustrate any material performance impact, Hale said that the Vanguard Small-Cap Index fund, over a three-year annualized return through July 2019, gained 11.01%. The losses over the period for both AOBC and RGR reduced the funds performance by 0.01% on an annualized basis.
Funds that do hold these stocks, albeit in small amounts, include American Funds iS Growth 1, American Funds Smallcap World, DFA US Small Cap Value, iShares Core S&P Small-Cap ETF, iShares Russell 2000 ETF, Vanguard Total Stock Market Index Fund, and Vanguard Small-Cap Index Fund.
I Want Out!
For investors who don’t want any exposure, no matter how small, there are funds that follow strong ESG practices and purposely avoid exposure to guns, tobacco and controversial weapons.
“For somebody who wants to avoid guns, it’s not like they need to look for a standard index,” Hale said. “They need to get in a kind of fund that not only isn’t involved in the civilian firearms industry, but funds that have a broader purpose of focusing on companies that address an array of social and environmental issues that they face in their business, and that helps them reduce the risks that could come from those issues and have a more positive impact.”
Some of those funds followed by Morningstar include the Ariel Fund, Calvert Small-Cap, Pax Small Cap, Walden Small Cap and Walden SMiD Cap. All these funds have a three-star or higher Morningstar rating, and a four globes or more sustainability rating.
However, these are only gun manufacturers. The largest gun retailer in the United States is Walmart (WMT), which is a large-cap stock and currently has about a 0.63% weighting in the S&P 500, says Hale.
“Most ESG funds don’t have Walmart in their portfolios,” Hale says, adding that it might not be due to its gun selling, but potential labor and supply chain issues.
Activism and Risk
Hale says that large funds — such as those of BlackRock and State Street — have become more active shareholders despite their passive investing.
“Funds say, ‘we’re in this together basically because it’s an indexed position, but you know we want to bring to [a company's] attention issues that we think could affect long-term value,’” he says.
Although companies might be moving toward ESG themselves to attract talent, Hale cites a recent Wall Street Journal story that said companies are starting to reveal risk of mass shootings at retail locations.
“They are putting it in their 10-Ks as a risk factor because it could affect the business and its reputation,” Hale said. “And it actually has a broader impact on society, extending to people not congregating in places where [mass shootings] happen. It’s a risk factor that companies ought to be playing a role to address.”
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