In the wake of the mass shooting at Marjory Stoneman Douglas High School on Feb. 14, where a former student killed 17 people with an AR-15 rifle, calls for gun reform have never been stronger. Activists have organized marches, boycotts, even televised town halls between lawmakers and the survivors.

A new mood of activism is also sweeping the investment world, where financial firms are increasingly rethinking their ties to weapons manufacturers, and investment funds—particularly ETFs—have come under pressure to divest the gun stocks in their portfolios.

While it's true some ETFs hold firearms makers, including the company that manufactures the AR-15 rifle used in so many mass shootings, ownership by passive ETFs in gun stocks is nowhere near that of actively managed funds.

Furthermore, divestment isn't as easy as it might seem. Passive ETFs are restricted in how they may rid themselves of their holdings in weapons manufacturers, since doing so might introduce tracking error. That's a problem actively managed funds don't have.

"Most active funds could sell their gun stocks tomorrow," said Eric Balchunas, senior ETF analyst for Bloomberg. "They really do have that liberty."

Which ETFs Hold Gun Stocks?

Though dozens of companies touch the civilian firearms industry in some way, the three publicly traded companies generating the most revenues from guns are:

  • Sturm, Ruger & Co (RGR), 95% of revenues
  • American Outdoor Brands Corp. (AOBC), 68%
  • Vista Outdoor, Inc. (VSTO), 49%

Forty-seven ETFs hold at least one of these stocks in their portfolios. The 10 with the largest ownership stakes are listed in Table 1, along with details of their holdings:

Table 1: ETFs With The Top 10 Largest Ownership Stakes In Gun Stocks
Ticker Fund Contains Total % of ETF Assets of ETF ($M) Total Assets ETF Invests in Gun Stocks ($M)
SPUN VanEck Vectors Spin-Off ETF VSTO   1.33% $4.81 $0.06
ITA iShares U.S. Aerospace & Defense ETF AOBC  RGR   1.14% $5,920 $67.49
XSHQ PowerShares S&P SmallCap Quality Portfolio RGR   0.54% $4.01 $0.02
FYT First Trust Small Cap Value AlphaDEX Fund AOBC   0.49% $73.68 $0.36
RZV Guggenheim S&P Smallcap 600 Pure Value ETF VSTO   0.47% $173.29 $0.81
IJS iShares S&P Small-Cap 600 Value ETF RGR  VSTO   0.40% $5,200 $20.80
SLYV SPDR S&P 600 Small Cap Value ETF RGR  VSTO   0.40% $1,230 $4.92
ISMD Inspire Small/Mid Cap Impact ETF VSTO AOBC 0.38% $28.84 $0.11
VIOV Vanguard S&P Small-Cap 600 Value ETF VSTO   0.38% $274.47 $1.04
EWSC Guggenheim S&P SmallCap 600 Equal Weight ETF RGR  VSTO   0.37% $32.37 $0.12

Source: ETF Channel, ETF.com, issuer websites. Data as of Feb. 26.

Most ETFs holding gun stocks are either small-cap funds that hold weapons manufacturers because of their small size; or single-factor funds, such as value or dividend funds, that include weapons makers based on the strength of their balance sheets.

ETFs Minimally Invested In Gun Stocks

Either way, these 47 ETFs devote only a tiny portion of their portfolio assets to gun stocks. The ETF with the largest percentage holding is the VanEck Vectors Spin-Off ETF (SPUN), which holds just 1.33% of its $4.9 million portfolio in Vista Outdoor. That position is worth roughly $60,000.

That said, percentages alone can be misleading: The $6.1 billion iShares U.S. Aerospace & Defense ETF (ITA), which has the second-largest percentage weighting, has a position in gun stocks worth $67 million.

Even given ITA's significant investment, however, the combined ownership of gun stocks by the 10 ETFs with the largest positions totals just $96 million.

Active Funds Dominate Ownership

In contrast, gun stock ownership by active funds, including mutual funds and hedge funds, swamps that by passive indexed products.

Table 2 compares the percent of shares outstanding owned by passive funds and active funds. For each of the three main gun manufacturers, active fund ownership significantly outweighs passive:

Table 2: Ownership of Gun Stocks
Name Biggest Shareholder Ownership by Passive Funds (%) Ownership by Active Funds (%)
Sturm, Ruger & Co. BlackRock 30.9 35.6
American Outdoor Brands Corp. BlackRock 21.4 34.5
Vista Outdoor, Inc. Fidelity 26.7 69.8

Source: Eric Balchunas, Bloomberg. Data as of Feb. 26.

Compared to passive funds, active funds own 13% more shares of American Outdoor Brands, makers of the AR-15 that was used in most of the recent mass shootings. In the case of Vista Outdoor, which manufactures hunting weapons and ammunition, active owns 43% more than passive.

It is true that the single largest stakeholders in these companies—BlackRock and Fidelity—are also asset managers that issue passively indexed ETFs. (Vanguard, State Street and Invesco are all significant stakeholders as well.) But this simply speaks to the concentration of passive assets in a few key names, says Balchunas.

"It's a question of optics versus reality," he explained. "Reality is that active funds are the largest shareholders [of gun stocks]. It's just that the ownership is spread out over 600 or so names, instead of two or three."

Pressure From Passive Funds

Yet it is these passive indexing giants (who, it should be noted, often manage significant assets in active products as well) that are leading the charge in applying pressure to gun makers.

Last week, BlackRock announced it would work with weapons manufacturers to "understand their response to recent events," said company spokesperson Ed Sweeney in an emailed statement to ETF.com.

‘Safe & Responsible Use’

State Street too has reached out to firearms makers. "We will be engaging with weapons manufacturers and distributors to seek greater transparency from them on the ways that they will support the safe and responsible use of their products," State Street spokesperson Andrew Hopkins told Reuters last week.

"Engagement" may take many forms. It could include shareholders encouraging gun retailers to impose restrictions on the kinds of guns they sell or to whom, or pushing manufacturers to incorporate "smart" technologies to limit usage of guns by unauthorized individuals.

It may also take the form of shareholder activism, including voting against directors or backing shareholder resolutions regarding gun safety at investor meetings.

History shows that large passive shareholders can affect significant change in the companies they invest in, especially if they work together. Last year, BlackRock, Vanguard and State Street teamed up to force ExxonMobil to report the impacts of climate change mitigation on its business, something ExxonMobil's management had long opposed.

"Even if all they do is engage in public debate, I think that matters, too," said Balchunas. "It sets the tone and gets people talking."

Divestment May Introduce Tracking Error

The one thing ETF issuers can't do—at least not easily—is divest from gun manufacturers. ETFs must remain true to their investment objectives, which is to replicate an index as it is, not as how investors would like it to be.

"An ETF can't just decide not to track certain stocks in the index stated in its prospectus," said Dave Nadig, CEO of ETF.com. "It would introduce tracking error and expose the fund manager to accusations that they're violating the letter and the spirit of their investment mandate."

Given the extremely small positions ETFs hold in gun stocks, any tracking error resulting from their exclusion would likely be slight. But it would be nonzero. "As a fiduciary, we have a responsibility to replicate the indices our clients choose to invest in," said BlackRock's Sweeney. "We invest in a company, as long as that company is in the relevant index."

What Indexers Can—& Can't—Do

ETF.com reached out to a number of index companies that all declined to speak on the record about what, if any, changes they planned to take regarding the inclusion of weapons manufacturers in their market cap-weighted indexes.

However, Meggin Thwing Eastman, head of impact and screening for MSCI ESG Research, told ETF.com the company is actively "updating" how it handles investor responses to guns. "I've had more press and client inquiries now than I've had in the wake of other mass shootings," she said. "It feels like the energy is different this time."

Currently, MSCI's ESG Research division offers three levels of exclusionary screens regarding firearms, based on a company's business model (e.g., civilian firearms producer, ammunitions manufacturer, retailer, and so on.)

Limited Options

But even indexers have limited divestment options, given that most gun manufacturers are privately held businesses and therefore ineligible for inclusion in their indexes.

Active fund managers, though, have fewer restraints when it comes to divestment. Since active managers are not forced to replicate a benchmark, they have the agility to rid themselves of whichever investments they choose, whenever they choose to do so.

As such, shareholder activism from active managers could potentially carry more weight, especially considering active's higher ownership stake in these companies. "People forget just how big active funds still are," said Balchunas.

Contact Lara Crigger at lcrigger@etf.com. To get the latest ETF news in your inbox, sign up for the ETF.com Daily Newsletter.

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