Think twice before dropping controversial stock holdings

Public pensions are scrutinizing gun stock investments, but private plan advisers may want to hold off

Jan 15, 2013 @ 1:12 pm

By Darla Mercado

Plan sponsors may want to hold off if they're thinking of selling stocks of controversial companies such as firearms manufacturers, despite the fact that some public pension plans are reviewing their holdings of such stocks.

New York state is the latest to freeze such investments. The New York State Common Retirement Fund confirmed on Tuesday that the fund -- which has $150.1 billion in assets -- is halting its investments in publicly traded commercial firearm manufacturers, The move follows Monday's call by Chicago Mayor Rahm Emanuel for five city pension funds to determine whether the fund managers hold equity or debt instruments from companies that either sell or make assault weapons. The review is the first step toward dropping the investments from the plans.

But financial advisers and ERISA attorneys warn that other employers should think twice before making similar decisions, particularly if such divestments could put a dent in a retirement plan's returns.

“From a plan standpoint, the primary purpose is to provide for the retirement benefits of the participants and beneficiaries,” said Richard K. Matta, principal at Groom Law Group. “Any other considerations have to be secondary.”

Indeed, companies like firearms manufacturers Sturm Ruger & Co. Inc. (RGR) and Smith & Wesson Holding Corp. (SWHC) have had strong returns, beating the broader S&P 500.

As of Jan. 14, trailing total annualized returns for Sturm Ruger were 39% for the one-year period, 72.73% for the three-year period and 48.08% for the five-year period. Smith & Wesson also experienced strong total returns, with 71.46% over one year, 24.16% over three years and 8.75% over five years.

By comparison, trailing total returns for the S&P 500 were 16.69% for the one-year period, 10.92% for the three-year period and 3.03% for the five-year period.

As a result, removing such holdings — as well as “vice” stocks — could create a damper on returns. The Vice Investor Fund (VICEX), for instance, returned 23.17% last year, 16.73% for the three-year period and 2.43% for the five-year period.

“All the work we've done on the subject suggests that if you go socially conscious, you should expect to underperform the S&P,” said Michael Francis, president of Francis Investment Counsel LLC. “That's not to say there aren't products out there that are consistently outperforming, but the overall impact has been a detractor to returns.”

Mr. Francis noted that he hasn't received any recent questions from plan sponsors about investments that are connected to the firearms industry, but typically, hospitals and other nonprofit groups are the ones who prefer to invest in a socially conscious manner.


On Jan. 9, the California State Teachers' Retirement Systems announced that it would start divesting from firearms companies that manufacture weapons that are illegal in the Golden State. Since then, several large funds have followed suit.

But employers seeking to replace their firearms stocks or other controversial holdings with something else need to consider the rationale for the switch, such as whether the fiduciary is making a prudent call that the divestment is financially safer, said Mr. Matta.

The Labor Department requires that such alternatives chosen by fiduciaries either be equal or superior to whatever investment they are replacing.

Chasing down which investments are tied to controversial industries could be easier said than done, particularly when taking a closer look at the underlying stocks inside mutual funds offered in a 401(k), noted George Fraser, managing director at Retirement Benefits Group LLC.

“How do you determine the relationship that those stock companies have with the gun companies?” he asked. “You may end up down to three mutual funds. At what point do you draw the line?”

As a result, it may make better sense for employers to draw a line between social policy and the returns they seek for their workers, said Marcia Wagner, managing director at The Wagner Law Group.

“An underfunded pension plan should have one goal in mind: 'What assets should we invest in to diminish the underfunded status?'” she said, noting that the caveat is that plans invest in accordance with the law. “Your primarily mission first and foremost is to provide a pension, not to determine social policy."


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