Gunmakers: Exclude or Engage?

TL;DR: With no end in sight to the gun control debate, institutional investors have an opportunity to make a difference. 

On 4 March, Smith & Wesson Holding Corp. (NASDAQ: SWHC) announced that sales grew by 61.5% in the three months ending January 2016. The increase appears to have been triggered by the 2 December 2015 mass shootings in San Bernardino and subsequently, President Obama’s executive actions to address gun violence.

Similarly, Sturm, Ruger & Company Inc. (NYSE: RGR) reported an increase in FY2015 sales to  $551.1 million from $544.5 million in FY2014. Net sales for the last quarter of FY2015 – marked by the San Bernardino shootings – rose to $152.4 million from $122.6 million the same period the previous year.

Over the last five years, the share price of Smith & Wesson has steadily gone up and the same trend holds true for Sturm. Reports indicate that gun manufacturers ironically benefit from the vicious cycle of gun violence and every presidential warning of stronger gun controls lead to stockpiling of firearms. Clearly, something ain’t working right here.

Firearms manufacturers have long been excluded from investment portfolios of most socially responsible investors for ethical reasons. However, exclusion has had mixed results and in this case, exclusion has not had a broader positive impact. Gun violence continues to grow and the political debate on gun control remains on a deadlock. Meanwhile, individual investors are exposed to the gun industry whether they like it or not.

Sleeping with the Enemy may not be a Bad Thing

With the seemingly impossible task of curbing gun violence through stricter gun control legislation, is it time for ethical investors to rethink exclusionary strategies? Is it time to consider being a shareholder in order to engage with gunmakers and come up with a win-win solution on gun control? A compromise is a tall order for both gunmakers and ethical investors, however, shareholder activism has a record of prompting behavior change in other companies in the past. Why not try engagement with the firearms industry?

Perhaps it also time for institutional investors to exercise more active ownership to create a positive social impact while reducing their reputational risk. As of 31 December 2015, the top institutional holders (above 2% ownership of outstanding stock) of Smith & Wesson included Vanguard (7%), Royal Bank of Canada% (RBC, 4.53), and BlackRock (total of 5.88%). The top holders of Sturm include The London Company of Virginia (12.05%) and BlackRock (total of 9.14%).

Both RBC and BlackRock have responsible investment (RI) policies stating the integration of ESG into their investment processes. BlackRock’s Investment Stewardship statement allows for engagement “on a range of ESG issues” while the RBC Global Asset Management and Corporate Governance Group’s RI policy defines engagement as “talking directly with companies regarding their ESG practices in order to influence how they conduct certain business activities.” While both institutions have traditionally focused ESG engagement on corporate governance, their RI policies appear to allow engagement on broader issues. Gun control is unlikely to become the subject of a shareholder resolution in the future due to securities rules over what should constitute formal shareholder action. However, there is also no barrier to institutional investors coming together to constructively engage on policy with the private sector.

The US Congress’ resistance to expanded gun control measures remains impenetrable,  largely due to the significant monetary support from the gun industry. If Congress remains unmoved, then perhaps a more viable means to an acceptable end is through the very industry that shows Congress the money.

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