Morningstar Magazine - April/May 2018 - 26

Dispatches

as American Outdoor Brands AOBC, which made
the AR-15 used in the Parkland, Fla., massacre
of high school students. Two other publicly traded
companies also make versions of the AR-15:
Sturm Ruger RGR and Vista Outdoor VSTO. The
publicly traded gunmakers are all small-cap
stocks, so if investors own a mutual fund with
small-cap exposure, they may be invested in guns.
We generated a list of funds with assets of
more than $1 billion that are invested in American
Outdoor Brands, Sturm Ruger, and Vista
Outdoor. The results: Driven by assets in index
funds, approximately two out of every three
dollars invested in small-cap funds have exposure
to guns. That exposure is spread across 264
open-end funds and exchange-traded funds.
American Outdoor Brands is owned by 197 funds,
Sturm Ruger by 252 funds, and Vista Outdoor
by 234 funds. Many funds own two or all three of
the stocks.
About 400 funds have no exposure, virtually all
of them actively managed funds. However,
these funds don't have as many assets as the
group of funds with exposure to guns.
If investors get their small-cap exposure through
an index fund, they are sure to be invested in at
least one of the gunmakers and probably all three,

depending on the index their fund attempts to
replicate. Gun-stock exposures are low, however,
ranging from 0.06% in the CRSP US Small Cap
Index used by Vanguard Small Cap Index VSMAX,
the fund with the largest asset base on the list,
to 0.23% for funds following the S&P SmallCap 600
Index. In total-stock-market index funds and
in extended-market index funds, these positions
are tiny, at a basis point or less.
Given the minimal impact on investment returns,
most index investors are not invested in
guns in a material way. But for many, any exposure
to guns may no longer be acceptable.
If investors get their small-cap exposure through
an actively managed fund, they have a
better chance of not being invested in any of the
three gunmakers. Compared with index funds,
actively managed funds hold far fewer
names, all of which a given portfolio manager
believes will contribute to outperforming
the market. With thousands of small companies
from which to choose, only some managers are
likely to select any of the gun stocks for
their portfolios. If investors do have exposure
through an actively managed fund, chances are
it's a modest position. We found only 10 funds that
held more than 1% in one of these
three names.

Small-Cap Funds That Exclude Gun Stocks
Name

Morningstar
Rating

Sustainability
Rating

Ariel Fund ARAIX

QQQQ

;;;;

Calvert Small-Cap CSVIX

QQQQ

;;;

NuShares ESG Small-Cap ETF NUSC

-

;;;;;

Pax Small Cap PXSIX

QQQ

;;;;

Praxis Small Cap Index MMSIX

QQ

;;

Shelton Green Alpha NEXTX

Q

;;;;;

Trillium Small/Mid Cap TSMDX

-

;;;;

Walden Small Cap WASOX

QQ

;;;;;

Walden SMID Cap WASMX

QQQ

;;;;

Source: Morningstar. Data as of 02/28/2018.

26

Morningstar April/May 2018

It's easy to find good funds among the 400
that do not have exposure to gun stocks, but few
actively managed funds carry any kind of
guarantee that they will never invest in guns. The
table below includes small- and mid-cap funds
that do not invest in weapons manufacturers as
a matter of investment policy.
There is one other question to ask, especially
if you are an index investor: Does the asset
manager engage with gunmakers on the safe and
responsible use of their products?
Because index funds have amassed a huge
amount of assets, when they buy even a tiny
position in a small-cap stock, they are gobbling up
a significant number of shares in the company.
At more than $700 billion in assets, Vanguard Total
Stock Market Index VTSAX, for example, is so
big that even though it has less than 1 basis point
of its assets in American Outdoor Brands,
it holds 2.4% of that firm's stock.
As a result, asset managers that run mostly
passive funds are the largest shareholders
in all three companies. As stewards of capital and
as major shareholders, these asset
managers have an obligation to engage with
company management.
BlackRock BLK and State Street STT have
signaled their intent to do so. Both firms also
indicated that they would also engage with gun
distributors, which implies conversations about
guns with larger retail companies that sell
them. As long-term permanent investors, giant
asset managers like these have a stake in
maintaining and strengthening the broader
social systems within which they invest,
because over the long run, healthy systems create
the conditions for better investment returns.
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 gunmakers at this
point should be an obligation.
Jon Hale, Ph.D., CFA, is director, sustainability research
with Morningstar global research. He is a member of the
editorial board of Morningstar magazine.



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