Activist Blowback: Divesting Threat

February 15, 2016 01:00 PM

Following San Bernardino, America’s mayors are renewing the divesting effort against arms manufacturers. 

In January, New York Mayor Bill DeBlasio urged all city public pension funds to divest any investments in manufacturers of civilian assault weapons. DeBlasio joins leaders like Chicago’s Rahm Emanuel and Los Angeles’ Antonio Villaraigosa, who both urged pension managers to dissolve stakes in guns and ammunitions firms. This isn’t DeBlasio’s first push into the boycotts, divesting and sanctions (BDS) movement. 

In September 2015, he urged pension managers to divest stakes in coal companies, while New York City council members pushed for complete divestment in all fossil fuel companies. 

The gun divestment effort surged in the wake of the Sandy Hook tragedy. Not only did many pension managers divest from gun manufacturers, but so too did many universities and mutual funds. The Campaign to Unload, which consists of more than 50 organizations, established a grassroots movement aimed at 401Ks.

“Divestment is a new front in the war against America’s epidemic of gun violence,” Jennifer Fiore, executive director of Campaign to Unload, said during the launch of its “Unload Your 401K.” program. “It’s time to defund the companies that profit from gun violence and obstruct the political change that would end it.”
By aiming directly at the $2 billion invested in gun manufacturers by 51 million Americans in mutual funds, divesting advocates argue are attempting to make a statement about gun violence in America, while encouraging socially responsible investments.

Social investment business

According to the Forum for Sustainable and Responsible Investment, approximately 18% of the $36.8 trillion in professionally managed U.S. assets is part of socially responsible investing efforts. 

However, based on previous divesting campaigns, don’t expect this to affect the company’s stock, while competing standards create challenges for money managers who are still measured by one thing: Performance. 

Gun divesting efforts have worked… socially

Following Sandy Hook, the California State Teachers Retirement System (CalSTRS) committed to full divestment from gun manufacturers. In 2013, the Teachers’ Retirement Board sold $3 million in shares of Smith & Wesson and Sturm, Ruger.

At the time, CalSTRS’ private equity partner, Cerberus Asset Management, faced a public relations problem. The Bushmaster XM15-E2S rifle used by Adam Lanza in the attack that killed 27 was manufactured by its wholly owned arms manufacturer Remington Outdoor, then known as The Freedom Group.

Three days after the attack, the $29 billion private equity giant issued a statement expressing condolences and vowing to divest its holdings in The Freedom Group. 

But several years later, Cerberus still owns the firm. Frustrated investors wanted to divest their stake, but no company seemed willing to pay $1 billion for the firm. Cerberus eventually struck a deal allowing investors to sell individual state’s stakes in the gun firm and shifted the arms manufacturer out of its primary funds and into a special financial vehicle. 

Today, Remington Outdoor is still still too big for a rival to absorb into their operations.

In 2014, they sold more than $1 billion in firearms and ammunition.

In comparison, the market capitalization of Smith & Wesson was $1.23 billion on Jan. 11, 2016, while Sturm, Ruger had a market cap of $1.09 billion. Vista Outdoor Inc., which trades at a much higher multiple than its peers, has a market capitalization of $2.89 billion.

At the same time that pressures are high to divest, one can’t ignore that level of sales.

Leaving money on the table?

Social efforts to divest can produce attractive investment opportunities for other investors. These factors were on display in the 1980s when social activists pressured universities to stop investing in the South African economy over its apartheid system. At the time, nearly 150 institutions divested. 

However, economists Hong Teoh, Ivo Welch, and C. Paul Wazzan determined that the efforts failed to place downward pressure on share prices and public market valuations experienced little change. The authors concluded that shares once owned by socially responsible investors were reallocated to “more indifferent investors and countries.” 

Simply put, divesting efforts of stocks with consistent demand created value opportunities for other investors. 

James Copeland at the Manhattan Institute explains that market prices have a funny way of moving back to equilibrium if value is created by divestment efforts.

“Unlike a boycott in a traditional goods market, the sale of a stock or bond in a financial market in sufficient volume to affect its price makes it more attractive to a buyer who doesn’t care about the divester’s social cause,” writes Copeland. “These buyers will bid the price back up to its equilibrium level, the risk-adjusted net present value of expected free cash flows from the instrument. So whereas a goods boycott can be effective under certain conditions, a stock divestiture never can unless there is insufficient liquidity on the other side, a highly dubious condition in our financial market.”

And while divestment advocates may argue their efforts are symbolic, such symbolism doesn’t fund steady returns for investors. 

That reality fueled snark from a writer of the UCLA Faculty Association blog when discussing a recent student movement to divest university pension funds from investments made in Turkey. 

The writer noted that divestment has little effect on the balance sheets of these companies, negatively affects the school’s investment portfolio and will no doubt force universities to seek alternate revenues streams in the future to fulfill obligations.

Said the UCLA blog: “So apparently there was not a doubt that it is a Good Thing to use the pension fund for political statements at a time when a) the pension is underfunded, b) there is a UC Regents dispute with the state over the state’s responsibility to fund the pension, c) employer and employee contributions are being raised at UC to cover the pension liability, and d) students are wondering if in some way their tuition will go up to help pay for that liability. Interesting!”

BDS movements at universities and in the public pension funds of police officers and city workers have targeted the oil-and-gas sector, the firearms industry, junk food, and even the only large-cap stock that rivaled Smith & Wesson over the last seven years, Apple, over its foreign labor practices. 

To engage in this level of divestment is to leave a lot of money on the table.

Creating a buyers’ market

Even though pension fund managers are divesting, there doesn’t appear to be a shortage of investors seeking alpha to purchase these stocks.

“I’ve talked to investors who say that they will not ever touch guns again as an investment,” says BB&T analyst Brian Ruttenbur. “But hedge funds and many other groups are willing to pick up those shares– no other companies are seeing 60% increases in demand for their products.”

One of those hedge fund managers is Louis Navellier, Chairman and Founder of Navellier and Associates. The day President Obama announced the latest round of executive actions, Navellier appeared on CNBC and recommended that investors buy the stock of gun manufacturers. 

“Mr. Obama is the best gun salesman on the planet,” Navellier said on Squawk Box.

Navellier is no stranger to either guns or the divesting movement. His firm has operated a number of socially respective accounts, including union accounts, religious organizations, and more.  

But no one has offered any pushback on gun stocks.

Navellier began accumulating a stake in both SWHC and RGR following the terrorist attack in Paris. Two months later, when the President began discussing executive action, demand surged. 

“I told CNBC, I’m not selling the guns. President Obama is selling the guns,” Navellier says. 

Navellier isn’t by any means a gun enthusiast. When he purchased his Nevada home, he turned the gun range that came with the property into a wine cellar. He has kept the guns he inherited from his father-in-law locked away for years. Simply put, he saw a profit opportunity and no investors objected to his position.  

That isn’t the case when it comes to a number of other investments out there. Navellier notes there is a stark divide between the divesting philosophies of the West Coast and the East Coast. 

The West Coast divesting effort tends to center more on reducing carbon emissions, while East Coast leaders tend to focus on divesting in companies with a nonunion labor force. 

“Everyone has a different standard,” he says. 

But it’s not just fund managers like Navellier who picked up shares in November and have seen profits since. TD Ameritrade’s Investor Movement Index tracks quarter-over-quarter trends of retail investment strategies. It is commonly believed that institutional investors shift into successful investments long before the “dumb money” – an ill-conceived moniker for retail investors – move into a stock. But the Investor Movement Index displaces that myth.

According to data in the index, retail investors dialed up their investment in Smith & Wesson from the third to the fourth quarter of 2015.

“Although institutional ownership in Smith & Wesson is very high (72%), the recent inflows were not just institutional,” says Nicole Sherrod, Managing Director, Trading at TD Ameritrade. “From November to December, we saw at 35% increase in the number of retail investors putting money into SWHC. And the month-over-month change in total assets invested in the stock increased by 59%. Conversely, our retail investors decreased their investment in consumer discretionary stocks by 2% during the same time frame.”

This level of investment signals that divesting messages are not stopping retail investors and that the demographics might not fit the advocates’ efforts. It may be working with millennials, who comprise just 4% of SWHC shareholders of the TD Ameritrade population.

But retail clients have more than $46 million invested in SWHC, 64% of the SWHC shareholders on the TD Ameritrade platform are seniors or baby boomers.

At a time that markets are volatile and commodities are tanking, it might take more than a hashtag to get retirees to let go of their gun stocks.

Divesting efforts will continue in the future, and while largely symbolic, their effectiveness may have the potential to grow as millennials boost their investments in the future. Until then, don’t expect SWHC or RGR stock to struggle, particularly as political noise accelerates in 2016.

About the Author

Garrett Baldwin is the Managing Editor of the Alpha Pages and the Features Editor of Modern Trader. An author and Baltimore native, he earned a BS in journalism from the Medill School at Northwestern University, an MA in Economic Policy (Security Studies) from The Johns Hopkins University, an MS in Agricultural Economics from Purdue University.