BlackRock’s gun-free funds show ethical investing is a good bet

Americans fed up with gun violence now have the chance to speak with their purses. Last week, BlackRock, the world's largest investment manager, said it was creating several options for investors who want to avoid AR-15 rifles and other civilian firearms.

Gunmakers and most gun retailers will now be excluded from BlackRock's broader socially responsible mutual and exchange traded funds. Such funds have historically excluded companies that make cluster bombs, nuclear reactors and cigarettes, while favouring companies that are rated socially responsible. BlackRock's institutional investors will be offered an even more targeted option: they can screen gun stocks out of their endowments and include gun-free index funds in their employees' pension plan choices without going the whole hog on ethical investing.

This level of pointed shunning is unprecedented for BlackRock. The investment manager began looking at the issue after the February massacre of 17 people at Marjory Stoneman Douglas High School in Florida sparked widespread protests against the US's lax gun laws. The move also comes shortly after BlackRock's chief executive, Larry Fink, warned companies that financial performance was not enough — they must also "make a positive contribution to society".

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That is a noble idea, but investors have long been wary about the potential impact on their portfolios of trying to do good, while also doing well financially.

"Sin stocks" — companies that sell alcohol, tobacco, weapons and gambling — have historically done better than the broader market. And Norway's recent experience tends to back this up. Its sovereign wealth fund began excluding such stocks from its broad based equity investments in 2004. That decision has cost it about 0.1 percentage points a year. On the other hand, the fund calculated that excluding individual companies over specific environmental, human rights and other ethical issues had boosted its returns by 0.04 percentage points annually. Over a 12-year period, the fund estimated that ethical investing cut returns by 1.6 per cent compared with its equity benchmark.

Norway believes that pressing its ethical agenda has been more than worth the small amount of lost earnings — the finance ministry expanded its ban to include big coal producers in 2016. It is debating whether to add oil companies to the list for financial reasons.

More and more investors are starting to follow their lead. The Global Sustainable Investment Alliance's last review found, in 2016, that nearly $23tn in assets were being managed under environmental, social and governance criteria, up 25 per cent from 2014.

These "ESG" strategies are not only becoming more popular, but also more sophisticated. For investors who want to follow their principles, but also track an index, portfolio managers are finding ways to "optimise" ESG funds by replacing excluded companies with additional exposure to groups with similar characteristics, but which do better on ethical and governance scorecards.

BlackRock found that it could improve a portfolio's ESG rating by one level (from triple B to A) and keep the tracking error below 10 basis points. A two-level increase to AA led to a 50 bps tracking error. And a 2017 study by Robeco, another asset manager, found sin stock outperformance could be replicated by screening for other kinds of investment factors, such as high profit margins.

In the case of US firearms stocks, investors who want to follow their principles and avoid the sector may be taking less risk than they once feared. After all, the US retail sector is struggling, including some of the most prominent owners of stores that sell guns: shares in Walmart, Kroger and Camping World are each down more than 15 per cent since the Parkland shooting, and Remington, a prominent gunmaker, declared bankruptcy in March.

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