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April 12, 2018

What We're Reading This Week

Author: Thad Schlaud

Topics: News, Industry Ideas

Gun violence and the stock market

It was hard for me to choose to write about this. Ultimately, I try to write about interesting aspects of finance and sometimes I try to be funny. There isn’t anything funny about gun violence, especially when it occurs at a school. However, it can have an interesting effect on finance.

Especially in today’s society, where retailers and investment companies face a tremendous amount of scrutiny from the public. So, what am I talking about? Mostly BlackRock. The company finds itself in a slightly awkward position.

Back in January, BlackRock CEO Larry Fink, wrote a letter to the world’s largest public companies telling them that they need to make a positive contribution to society in order to receive support from BlackRock, an investment manager controlling more than $6 trillion in assets. Sort of. See, a lot of BlackRock’s funds are held in passive investments. Sure, there are actively traded mutual funds but there are also index based mutual funds and ETFs. This is problematic for BlackRock and Larry Fink’s letter. How can BlackRock remove companies they don’t like from their passive investments? One answer would be to create new funds that specifically disclose the exclusion of “bad actor” companies and let consumers decide which funds to own. This still puts the decision in the hands of the individual investor, not BlackRock. My point is, BlackRock doesn’t really have the clout to make demands like that.

The other thing BlackRock could do is vote on investor proxy ballots in order to effect the changes it wants to see. This would probably be more successful but equally problematic. It sort of defeats the purpose of a passive investment, doesn’t it? It really sounds more like active investing than passive investing.

Well, the whole thing became more complex after the shooting tragedy in Florida in February. BlackRock is the largest shareholder in the company that manufactured the gun used in the shooting. When you publicly call out large companies for not contributing to society it really helps if you are doing it yourself.

Now, to be fair, BlackRock was just doing the passive investment thing. If you’re BlackRock and you have a fund that invests in an index that contains gun manufacturers, you sort of have to invest in gun manufacturers. It’s still not a great look and as you can imagine, BlackRock has faced additional pressure to take action. So it looks like the company will elect option 1 and 2.

Option 1, offering investors fund options that do not include gun companies makes a lot of sense to me. Ultimately, consumers can decide which fund to buy. Option 2, visiting publicly traded companies and pressuring them to change their business practices based on a threat that you don’t have the authority to make is a little weird to me. Pressuring gun manufacturers to make guns harder to buy in the first place is odd. Initially, I like it. Guns should be hard to buy but typically investors are visiting boardrooms to pressure companies to sell more of their products, not less. Look at it from the gun company’s perspective. Most individuals that buy gun company stock like gun companies. They also want their stock to go up. That usually happens when the companies sell more guns. Now, BlackRock is coming in and telling them to make guns harder to buy, however, most of the money BlackRock has invested in the company has to stay invested in the company. Because it is index based, BlackRock can’t sell those shares! Additionally, BlackRock is offering new funds that don’t include gun manufacturers; further reducing its negotiating position. The gun companies are really not accountable to BlackRock in any way. It really feels like a PR campaign and little else. Put differently, if BlackRock was truly interested in changing something at the corporate level, it should really be looking for ways to invest more funds in gun companies, thereby increasing the number of proxy ballots it can vote with.

Altogether, the idea that corporations, and tangentially the corporations that invest in them, are responsible for social activism is strange. I may be “old-fashioned” but I always thought the corporation’s job of creating something and selling it was its contribution to society. If they are successful, then they can employ lots of people and that’s another contribution to society.

Certainly, some companies have made socially responsible ideals part of their brand. And consumers can choose to buy those products and invest their savings in those companies. Investing in an index fund with broad market exposure is a great way to grow your wealth. Investing in an index fund that allows Larry Fink to make empty threats to corporations isn’t necessarily bad, it’s just an odd way to grow your wealth.

 

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