Opinion

The Great Debate

Let’s stop investing our retirement funds in lethal weapons

By Adam Kanzer
January 9, 2013

Mutual funds, according to a recent Vanguard statement, are not “optimal agents to address social change.” I agree. But while a mutual fund may not be the best way to promote sound social policy, when trillions of dollars in mutual fund assets are managed without any social or environmental considerations, they can be a very effective way of promoting broad social harm.

Unlike other national tragedies fueled in part by investment decisions – the BP disaster immediately comes to mind – the Newtown massacre has prompted an important and overdue debate about the role of investment in our society. Your IRA is at the heart of that debate.

We’ve read about how the retirement funds of teachers and other public servants were used by Cerberus, a private equity fund, to create Freedom Group, the largest gun maker in the country. Freedom Group makes the assault weapon that was used to kill children and teachers. Unless you are a participant in a public pension fund, or a very wealthy individual, however, you are probably not invested in any of the private equity firms that own gun makers. But you are most likely invested in a mutual fund, and your fund may own gun stocks.

Vanguard’s statement was issued in response to the revelation that it is one of the largest owners of Smith & Wesson and Sturm, Ruger, the largest publicly traded gun manufacturers.  Vanguard holds these stocks in passively managed index funds. This, of course, is no real revelation – it is the status quo, the result of a philosophy that treats investments as abstractions, divorced from real world impacts. But it should serve as a wake-up call for the millions of Americans invested in so-called ‘low cost’ index funds. What are the true costs of these investments?

Vanguard’s statement, which could have been issued by any large asset manager, contains two of the most common excuses offered for failing to address the social implications of investment decisions. Let’s take each in turn.

The first statement involves benchmarks. Vanguard is the inventor and largest manager of index funds – ‘passive’ funds designed to replicate benchmark indices. Smith & Wesson, Sturm, Ruger and ammunition maker Olin are members of the Russell 2000 and Russell 3000 indices. In essence, Vanguard claims that its hands are tied – to track an index, it must invest in all the stocks in that index. But is this true? Is it possible for an index manager to track a 3000 stock index with 2997 stocks?

Does a passive investment strategy relieve an asset manager of all moral responsibility? Do managers have an obligation to choose appropriate benchmarks that do not contain inherently destructive companies?

If an index strategy requires automatic investment in destructive companies – landmine manufacturers, human rights violators, gun-makers – then safeguards need to be put in place to allow passive investment while also protecting innocent third parties. Ultimately, this responsibility should rest with the firms that manage the benchmarks themselves. Generally, companies are selected for major market indices without any consideration of their social or environmental impacts. But what if Russell decided to assess the true value these companies contribute to society? What if Russell identified a set of corporate practices that pose unacceptable risks, and then chose to remove those companies from their indices? Every index manager in the world would divest overnight.

If there’s anything we’ve learned from the financial crisis, it is that even the most arcane financial decisions can have real-world impacts. Such is the case when you allocate billions of dollars to companies that make military-style assault weapons. We can no longer pretend that these decisions are morally neutral – they are not.

Standard-setting is not foreign to index management. Both the index managers and the stock exchanges set all sorts of financial and governance standards. The OMX Nordic Exchange actually has a standard to “investigate”, and presumably to ultimately delist, companies that have committed “serious or systematic violation of human rights or other ethical international norms” including those that manufacture chemical weapons or land mines. They placed these standards under the heading “marketplaces with integrity.” After OMX’s acquisition by NASDAQ, it is unclear where those standards now stand.  Some exchanges, including the Johannesburg Stock Exchange, require listed companies to produce sustainability reports.  Dow Jones, MSCI and FTSE all maintain indices that include social and environmental standards.

Should investors be able to choose between both responsible and irresponsible indices? That depends on whether you believe there are real-world consequences for allocating capital to firms that are hurting people.

Vanguard’s second claim, drawn from its longstanding statement on social issues, is that “as a fiduciary” it is required to “maximize returns.” Whenever you hear that phrase, add three simple words: “at any cost.” Pure profit seeking should never be conflated with fiduciary duty. Fiduciaries are held to a higher standard.

The 19th century ‘prudent man standard,’ for example, directs trustees to “observe how men of prudence, discretion and intelligence manage their own affairs.” When fiduciaries manage money for parents, they need to think like parents. It is self-evident that a prudent person would not use her own money to harm her children. It is both callous and misguided to suggest that fiduciaries are compelled to do so.

The long-term rationale for investing in gun manufacturers is the belief that society will not act to rein in the costs these companies impose on others. The largest asset managers in the world are backing a future that fails to address broad social harm. They have placed many billions of dollars of other people’s money on the laissez faire side of the scale, and they have done this despite a clear legal obligation to put their investors’ best interests first. We should therefore not be surprised to see our children inherit a passive democracy that is unable or unwilling to protect them.

I believe divestment of stocks in gun manufacturers is appropriate, but there is more that can be done. Beyond divestment, institutional investors – including mutual fund managers – should be using their clout to place this issue on the agenda of every board in the country. Directors should be asking whether their company’s products, services and political activities are contributing to this epidemic of violence, or standing in the way of reform. Many companies, including those that manage theme parks, operate stores in large shopping centers, or are closely associated with children, could benefit from strict gun control. These companies should stand up and say so. Video game companies that partner with gun makers to help market assault weapons should be asked to review these practices. Every retailer that sells semiautomatic weapons should be asked to take them off the shelves. In addition, as we wait for stricter gun control laws, there is no reason why companies that sell guns cannot impose strict rules of their own.

Money managers, unlike individual investors, have a legal obligation to think about the welfare of others. When trillions of dollars of capital unite against gun violence, companies and policymakers will listen. Institutional investors are not prevented by fiduciary duty from taking these actions; rather, fiduciary duty compels them to do so.

Let’s apply a little common sense. We don’t need to finance violence in our communities in order to provide for our retirements. Now is the time for individuals to speak up and demand an approach to investment that is appropriate for children.

PHOTO: Crosses are seen at a memorial along the side of the road on the day the Sandy Hook School children will begin to attend classes in Monroe, Connecticut, January 3, 2013. REUTERS/Carlo Allegri

Comments
11 comments so far | RSS Comments RSS

“Freedom Group makes the assault weapon that was used to kill children and teachers.” So Mutual Funds never invested in anything else that ended a life? No knife makers, auto makers, baseball bat makers, etc? I will invest in anything available to me that has a gain and so will anyone else. I’m forced to pay taxes that are used for the direct execution of people without my consent. Until that stops, you can take your “prudent man standard” and shove it. If we don’t need to “finance violence in our communities in order to provide for our retirements”, then look at the number one killer on the planet and fight that. Government. Otherwise, please stop arguing against the lone bee while ignoring the hive.

Posted by LysanderTucker | Report as abusive
 

Our “author” is “Managing Director and General Counsel of…” “…of a family of socially responsible mutual funds”? Puleeze. Let’s see the hand of those who believe this guy, whose bread and butter is made making investors feel guilty, doesn’t have his own “agenda” for hard-earned money?

“..the Newtown massacre has prompted an important and overdue debate about the role of investment in our society.” Nope. Humans massacre each other all the time. And each time the “liberals establishment, unwilling to let any tragedy go to waste, emerge from under their rocks in droves to “debate” with statistics carefully cherry-picked for emotional impact simply because they have learned that every time this subject is discussed from a logical basis they LOSE.

You challenge “…a philosophy that treats investments as abstractions, divorced from real world impacts…” [of] “…the millions of Americans invested in so-called ‘low cost’ index funds.” “Our” government has created a “new investment climate” in which most Americans can not preserve purchasing power if they deposit “savings” in a bank, credit union, money market or government bond. Precious few Americans can today afford the moral standards you would establish as a “standard”.

And let’s get one thing straight. Those who manufacturer guns are no more “collectively responsable” for an individual or group’s misuse of their product than those who manufacture chemicals or refine minerals or make electricity or do any of the things that enable our society to function. Nobody wants to think of the little bunny rabbits that get swept up and baled with each cutting of hay, but they’re in there and they always will be because it’s too expensive to protect them and still grow, cut and sell hay.

When some sociopath is kicking in my front door, my safety and that of my family depends on our prior preparation. This is the “violence”, whether or not they have a gun, that threatens our society day by day. My wife isn’t equal in strength to some crackhead idiot, but her gun and training will assure it is HIS family on the evening news trying to convince viewers what a wonderful life of great potential was “cut short”. If you want to donate the safety of your wife and family, that’s between you and them. Be my guest.

So long as “human nature” is as it is, the civil in our society must each be ready to do their part in discouraging or thinning out those who would tear it down or apart. If propagandists like you ever succeed to the point that only the “bad guys” have guns and “we, the people” have only box cutters or utility knives with which to defend home and hearth knnow wiith certainty that you will eventually hear the knock at your door of people with torches and a stout rope.

We already know that society is all but powerless to rein in the costs of an ever-growing lawless underclass since “our” choices are to kill them or lock them away most of their lives. It is THESE costs you should be concerned with, and not trying to deprive hard working citizens of the protection any law enforcement officer will admit that they cannot provide “24/7″ anywhere.

And well said, LysanderTucker!

Posted by OneOfTheSheep | Report as abusive
 

“I believe divestment of stocks in gun manufacturers is appropriate”

That’s is fine and dandy to have that belief.

Then they should also divest of any Defence Contractor stocks too. For the products they make kill children and teachers around the world.

Posted by Harry079 | Report as abusive
 

I see perusing the prospectuses of your funds Mr Kanzer that you have no problem investing in pharmaceutical companies. You are are aware that prescription drug abuse is a huge problem?

The CDC says prescription drug overdose deaths have tripled since 1990 and as of 2008 the United States was experiencing 12 deaths per 100,000 population due to overdose. You realize that exceeds gun deaths?

But hey, you’re selling rich people feel good investments and no doubt making a fine living at it. The ducks quack and you feed them, no point in worrying about dead children that no one is noticing.

Posted by CaptnCrunch | Report as abusive
 

Thanks for the reminder. I am checking the prospectus on my Vanguard dividend fund. Small step, to be sure – but anywhere is a good beginning. Pharm companies don’t force anyone to take their medications, and they don’t take lives from the luckless who are simply in the wrong place when a shooter decides to go off

Posted by auger | Report as abusive
 

How about mentioning Boeing, Lockheed-Martin, Raytheon, General Dynamics, et. al.?

Don’t their products kill more people that Smith & Wesson and the other gun manufacturers?

Posted by upstater | Report as abusive
 

What about aerospace and defense investments – these are the highest in lethality. Unfortunately, we live in a world with competition and bad people and we can’t end guns anymore than we will be able to keep iran nuke free. Its the same tired nonsense from the 60′s “what if we had a war and nobody came” – nice idea, but it never has and never will happen.

Posted by zotdoc | Report as abusive
 

Oh gosh darn! I guess I must sell my McDonalds stock holdings [fat kills you know], there goes my Ford stock [carbon footprint and cars kill], Exxon [big oil]. Anyone know of any good Amish-based firms?

Itis so hard to be politically corrent these days.

Whats a liberal to do?

Posted by ugrant21 | Report as abusive
 

Let’s stop sending our tax dollars to countries like Israel who have seen a 20% increase in weapons sales – and those sales might be to countries who hate the US. Sheesh – we’re not even getting a dime back from Israel for our dollars that go that country.

Posted by AZreb | Report as abusive
 

The following is a project for a business ethics course which requires me to post a reply to an article, hence the length and the format.

I would like to comment on is your idea that if a fiduciary manages money for parents, it must think like a parent and invest the funds accordingly, i.e. not invest in gun manufacturers.
The first problem with this idea is that it is impossible to know what another person is thinking; it is impossible to think like a parent. There are poor parents, rich parents, parents of all different religions and ethnicities, and, heaven forbid, I am sure there are a large number of parents who are members of the NRA. To think like a parent might be to have a wish to protect and nurture children, but all of these different groups and each individual parent within them have a different way of wanting to achieve this. So it could be quite difficult for the fiduciary to ‘think like a parent’. For similar reasons it could also be quite difficult for the fund managers to use the prudent man test in this sort of ethical dilemma- my prudent man may be pro-gun/nuclear power/war on terror, your prudent man may not.

While you are correct that a prudent person would not use their own money to harm their children, there are two problems with this logic in terms of owning shares in a gun manufacturer. The first is whether or not you believe that owning or selling stocks in a particular company encourages that company to grow or fail; if the company grows presumably the amount of harm caused by the company also grows. In most stock transactions the bottom line of the company is not affected- so the company does not grow because of investors exchanging shares, and as quick as one investor sells them they are purchased by another. The stock price may fall but given time it may rise back to previous levels; the only thing that would cause a gun manufacturer to fail is if it couldn’t make a profit making and selling guns anymore. If it became socially unacceptable for most people to own stocks in these types of companies then gun manufacturers may find it hard to raise capital by selling shares, and new companies may find it hard to get start up investment; but I would suggest that as long as there is a return to be made on investment there will be willing investors.

The second issue with this logic is whether you believe that guns are intended to harm children, I don’t believe they are created nor intended for this purpose. However in Newton a man did harm and kill children with guns. Guns are certainly capable of this; so are trampolines, ponies and fast food, in fact in 1999 there were almost 100,000 emergency admissions caused by trampolines in the USA (FSCIP, 2011). None of these products primary purpose is to harm children, but improper use has the potential to harm and even kill, just as improper use of a gun does. Does this mean we should divest our money from all products that have a potential for causing harm? This would make investment difficult, and a definition of what constitutes enough harm to warrant divestment would need to be established (as opposed to a knee jerk response to public outcry).
This sort of idea aligns with Freeman’s stakeholder theory proposes that managers (trustees in this case) must take into account the possible benefits and harms to all stakeholders when making a decision, and the harm or benefit that the decision may cause them (Freeman, 2004). I would argue for Friedman’s stockholder focused view; that it is not the place of business to police society, only to act within the law and the reason that stockholders participate in these funds is primarily fiscal. Any deviation from an attempt to increase profits legally is in contrast to this (Friedman, 2005). If this were not the case the stockholders would have invested in one of the many ethical funds, however these tend to perform poorly compared to ‘sin stocks’ (Randall, 2009).
This brings me to my next point- it is unethical for a trust to change its investment strategy on a whim, or to public pressure. I believe the only thing that should encourage a trust to make major changes to its investment strategy is a referendum of its investors. This is because these people have used their free will and rational autonomy (The Open Polytechnic of New Zealand, 2009), to choose to enter an agreement with the trust presumably based on its previous performance and its investment strategy. For the directors to suddenly change the investment strategy is for them to violate the basis of the agreement, unless the directors are elected for a period by the investors based on their character and past performance to manage the funds as they see fit. For example, if I wanted to save for a university education for my child and I signed up to a trust because it had produced good returns over time and had a policy of following certain indexes which tended to achieve these good results, if, without consultation the trust decided to exclude certain, previously well performing, stocks from its books which could affect the performance of the entire trust and in turn affect my ability to provide an education for my child, this would violate the agreement I had, and so be ethically wrong.

Posted by Rasputin5 | Report as abusive
 

another limo liberal who wants to push an agenda with my money.
I am happy with my returns from vanguard, and more than happy with the way they invest.

Posted by nicholas2 | Report as abusive
 

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