ETFs Pressured To Drop Gun Stocks

March 01, 2018

Divestment May Introduce Tracking Error

The one thing ETF issuers can't do—at least not easily—is divest from gun manufacturers. ETFs must remain true to their investment objectives, which is to replicate an index as it is, not as how investors would like it to be.

"An ETF can't just decide not to track certain stocks in the index stated in its prospectus," said Dave Nadig, CEO of ETF.com. "It would introduce tracking error and expose the fund manager to accusations that they're violating the letter and the spirit of their investment mandate."

Given the extremely small positions ETFs hold in gun stocks, any tracking error resulting from their exclusion would likely be slight. But it would be nonzero.

"As a fiduciary, we have a responsibility to replicate the indices our clients choose to invest in," said BlackRock's Sweeney. "We invest in a company, as long as that company is in the relevant index."

What Indexers Can—& Can't—Do

ETF.com reached out to a number of index companies that all declined to speak on the record about what, if any, changes they planned to take regarding the inclusion of weapons manufacturers in their market cap-weighted indexes.

However, Meggin Thwing Eastman, head of impact and screening for MSCI ESG Research, told ETF.com the company is actively "updating" how it handles investor responses to guns.

"I've had more press and client inquiries now than I've had in the wake of other mass shootings," she said. "It feels like the energy is different this time."

Currently, MSCI's ESG Research division offers three levels of exclusionary screens regarding firearms, based on a company's business model (e.g., civilian firearms producer, ammunitions manufacturer, retailer, and so on.)

Limited Options

But even indexers have limited divestment options, given that most gun manufacturers are privately held businesses and therefore ineligible for inclusion in their indexes.

Active fund managers, though, have fewer restraints when it comes to divestment. Since active managers are not forced to replicate a benchmark, they have the agility to rid themselves of whichever investments they choose, whenever they choose to do so.

As such, shareholder activism from active managers could potentially carry more weight, especially considering active's higher ownership stake in these companies.

"People forget just how big active funds still are," said Balchunas.

Contact Lara Crigger at [email protected]

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