Gun stocks trigger issues for investors, fund managers

Fresno Bee
Fresno Bee
Posted: February 10, 2013

Are there guns in your investment portfolio?

Gun control is the kind of issue that can wake you up to the fact that the money in your fund portfolio or 401(k) affects more than just your retirement security. The financial markets support all kinds of companies, including some you might not believe contribute to the greater good.

Removing investments from a portfolio on moral grounds isn't always a simple matter. There are potential costs to putting principles before profits.

Over the last 10 years, Smith & Wesson has posted an average annualized return of 17 percent, compared with the 8 percent return of the broader market. Similarly, Sturm, Ruger & Co., the largest publicly traded gun company, has returned an annualized 23 percent over that time.

There would be other potential costs if fund companies or 401(k) managers were to sell gunmaker stocks in response to the debate's recent resurgence. These companies have obligations to serve the financial interests of vast numbers of individual fund shareholders and plan participants with varying opinions about guns.

For employers sponsoring 401(k) plans, their hands can be tied unless the plans established mandates to avoid investing in gunmakers, says Kathleen McBride, founder of the consulting firm FiduciaryPath. She advises financial professionals who are fiduciaries, a legal designation requiring them to act in the best financial interests of their clients.

That obligation is a chief concern cited by Vanguard, one of six fund companies Chicago Mayor Rahm Emanuel has written, seeking to pressure them to sell their stock in gunmakers. A Vanguard spokeswoman said mutual funds "are not optimal agents to address social change."

A spokesman for American Funds, which heard from Emanuel, too, said: "If social issues may have an effect on the investment potential of a company, we take those issues into account as part of the investment process."

For example, a stock-fund manager might expect that gun laws are likely to become more restrictive. That would cut into industry sales, leading the manager to conclude that stocks of gunmakers are bad long-term investments. The fund manager could justify selling such stocks as beneficial for shareholders. But the manager would not be justified in selling simply because of moral objections.

Making changes gets more complicated with low-cost index funds, which own all the stocks in a given market index.

If such a fund doesn't track the index closely, then it ceases to be an index fund, no matter if some stocks are viewed as morally objectionable by some investors.

For example, Vanguard is the biggest manager of index funds, and its $5.4 billion Small-Cap Index Fund is the largest fund owner of Smith & Wesson shares, according to Morningstar.

The fund, a common investment option in 401(k) plans, recently held 1.6 percent of Smith & Wesson's outstanding shares. But that stock made up just 0.04 percent of the fund's total assets, because the fund owns more than 1,000 stocks in the small-company index that it tracks.

In fact, with $2 trillion in assets, Vanguard owns stakes in nearly every publicly traded U.S. company. That's also the case with other large fund companies offering index funds that own hundreds or even thousands of stocks. The more broadly diversified a fund is, the greater the likelihood you'll find something you dislike.

How to avoid links to gunmakers in a portfolio?

Choose funds that track large-company indexes. Smith & Wesson and Sturm Ruger aren't big enough to be included.

If you want active management, check a fund's latest holdings online for any gun stocks. Chances are small that you'll find any, but be aware that the manager could invest in them at some point, unless the fund has a specific mandate to avoid them.

Or, better yet, invest in funds that explicitly avoid certain stocks based on moral criteria. Some larger fund companies, including Vanguard, offer funds that seek to invest based on social objectives. And dozens of smaller companies specialize in socially responsible investing, offering funds that screen out everything from gun- and tobacco-related stocks to companies that charge interest on loans.

There also are lower-cost funds tracking indexes limited to stocks deemed socially responsible.

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