Lawyers, Guns and Money (and Index Funds)

Who Owns the Gun Makers?

Worldwide sales of guns and ammunition total $17 billion annually.  It’s big business, with lots of investors.  BlackRock, the world’s largest asset manager ($6 trillion), recently posted a piece about investing in the industry.gun

BlackRock noted that its gun investments were all in index funds, which own a non-discretionary, broad “basket” of companies, like those in the S&P 500. BlackRock cannot sell shares of an individual company in the index, even if it is worried about that company’s performance. Their only affirmative option is talking, a process they have initiated with gun makers.

This seems noncontroversial. It is natural that BlackRock, a fiduciary for its investors, would ask gun manufacturers to review their practices after the significant public reaction and activity since Parkland.

Your Money or Your Life

But this leaves a fundamental question unanswered: what if the actions that are best for schoolchildren are not the actions that are best for shareholder return?  According to Andrew Sorkin, a leading business journalist, the answer is clear: fiduciaries answer only to financial value:

BlackRock is a fiduciary so it must make a financial case for such changes — showing that taking those steps would turn out to be more profitable in the end. It can’t simply press for such action on moral grounds. (New York Times DealBook, March 5, 2018.)

So if it produces the highest return, BlackRock has a legal obligation to support the companies in selling as many assault rifles as they can, regardless of how many schoolchildren die. It’s their “fiduciary duty.”


Index Funds Depend on Healthy Systems

Sorkin is not alone—our entire financial system is permeated with the concept of “shareholder primacy.” But the idea that investment managers are legally compelled to cause each separate company in a portfolio to create as much return as possible is doubly wrong.

First, it’s wrong in the simple factual sense of “incorrect.”  All the shares that BlackRock owns in gun makers are held in index funds.  The performance of indexed investors is based on how the indexed market performs, not how one company performs.

Index funds should focus on how gun sales gun affect the systems upon which all of the companies in the index depend. This is no small point. By 2025, it is estimated that half of the stock market will be held index funds.   Even most non-indexed investments are held in diversified portfolios that are largely dependent on overall market returns.

Investors should be asking how much gun violence costs the economy in medical care and lost wages.  How much of our educational budget is spent on protection? How is the tourism industry affected?  Can gun makers alter these outcomes?  The answers will determine the effect of gun sales on the economic, educational and social systems in which all companies operate.

These items are much more likely to affect the financial return to a diversified investor than is the performance of a single company. Moreover, investors are people, and may be directly affected by systemic costs and risks (or stray bullets). An investment steward must think systemically in order to serve the interests of investors, and sometimes a fiduciary can forgo a gain at an individual company in order to preserve systemic value, and thus the value of an entire portfolio.

Human Investing

As compelling as this financial “wrong” consideration is, there is a second “wrong”—the moral one.  Consider a corporation with reprehensible practices that are legal, systemically neutral, and provide the best return for its shareholders; perhaps a retailer’s decision to use the cheapest supply chain, knowing it includes factories like Rana Plaza, where 1,129 people burned to death in 2013.

I cannot believe we would tolerate a legal system that imposed a duty on BlackRock to encourage such behavior, even if it offered the best financial return. In the words of Cornell Law Professor Lynn Stout, the law does not reduce investors “to their lowest possible human (or perhaps subhuman) denominator . . . psychopathically indifferent to others’ welfare.”

BlackRock and other large investment managers, like State Street and Vanguard, should continue to engage portfolio companies on issues that affect our planet, its inhabitants, and future generations.  These include weapons sales, but also resource use, carbon emissions, investment in workers and human rights issues within their supply chains. In our interconnected world, preserving these systems is the only way for investors to earn a competitive return over the long term.  But just as importantly, it is the only way to do business in a civilized society.

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