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Handguns sit in a display case at Frontier Justice in Lee's Summit, Mo.Charlie Riedel/The Associated Press

When financial planner Tim Nash found a gun-related stock in an ETF in his portfolio, he sold his stake in the fund.

Mr. Nash, founder of investment-coaching firm Good Investing, noticed that Missouri-based Olin Corp., a chemical products and ammunition manufacturer, was included in Blackrock’s iShares Global Water Index ETF (CWW), which focuses on water infrastructure.

While Olin itself isn’t a gun manufacturer, the name raised a red flag for Mr. Nash, whose focus is socially responsible investments.

After a few clicks, he found that Olin owns Connecticut-based firearms maker Winchester Repeating Arms Co.

“If you were going through a list of companies and saw Olin Corp., you probably wouldn’t bat an eye,” Mr. Nash says. “Olin Corp. was only about a per cent in that water ETF, but I’m the type of person where I say that not one penny should have exposure to weapons.”

There’s greater scrutiny on gun makers and retailers today amid an increase in mass shootings and other incidents of gun violence in the United States and around the world, including Canada. Some investors and activists are urging fund managers to drop firearms companies such as Sturm Ruger & Co. and American Outdoor Brands Corp. from their broader index funds.

But as more investors turn to ETFs, they may be unwittingly buying into gun stocks, even if those funds are socially responsible.

A 2018 Sustainalytics report found that 24 per cent of all ETFs and 15 per cent of all mutual funds hold at least one of the 40 public companies in the global firearms industry. And while socially responsible funds such as Vanguard’s ESG U.S. Stock ETF (ESGV) and robo-adviser WealthSimple’s inclusion of the iShares MSCI ACWI Low Carbon Target ETF (CRBN) in its socially responsible portfolio exclude civilian gun manufacturers, the funds still include gun retailers such as Walmart Inc. and Dick’s Sporting Goods Inc., and makers of military and nuclear weapons.

The “devil is in the details,” Mr. Nash says, when investors are looking to build their environmental, social and governance (ESG) portfolios.

“It gets very challenging due to the way that ETFs are made up,” he says. “Some ESG funds go further than others when it comes to ESG analysis. When you open up an ETF and look at what’s inside, there are things in there that most Canadians would not consider socially responsible.”

Whether an ETF includes gun-related stocks depends on the institutional investor’s methodology in building the fund. To screen for companies indirectly involved in firearms, fund managers set a threshold for the amount of revenue that comes from guns. If a company, such as a retailer or owner of a gun company, falls below that threshold, it could pass the screening and be included in the fund.

In ETFs with particular investment objectives, such as a water or low-carbon fund, the manager will apply a narrow screen for particular types of businesses, says Steven Leong, director of iShares Canada products at BlackRock Asset Management Canada Ltd. Meanwhile, companies that may be against other investor values could slip through.

“The water ETF is very narrowly focused on companies that are involved in industries that are potentially affected by water scarcity,” Mr. Leong says. “A firearms screen may just not be applied to that universe because it’s targeted on a different set of issues and objectives.”

But focusing on just one socially responsible principle isn’t enough for many ESG-oriented investors who seek to exclude all companies and industries that clash with their values. While gun-control activists push for large investment firms to exclude gun companies from broader index funds, Mr. Leong says that this would preclude certain clients from investing with the firm by forcing them to abide by certain values and could also affect returns.

“The more screening and more exclusionary criteria that you apply, the more difficult it is to be confident that you’ll achieve a similar return to the overall market,” he says. “Because you have this potential performance impact on the way you think about the product in a portfolio-construction context, you’ll always have different variations in the market based on the strategy.”

As more Canadians put their money into ETFs, recent research has shown that some socially responsible investments are outperforming the market. Seventy-five per cent of Canadian responsible-investment funds outperformed their average asset-class return in the second quarter of 2019, and nearly three-quarters outperformed for the year ended in June, according to the Responsible Investment Association (RIA).

When looking to remove guns from their portfolios, investors should ask fund managers if they apply ethical or exclusionary screens when building ESG funds, according to Dustyn Lanz, RIA’s chief executive officer.

“It is important to note that not all funds that are marketed as responsible or sustainable will have a mandate to do exclusionary screens,” Mr. Lanz says. “When a fund is conducting ESG integration, the portfolio manager will combine ESG analysis with financial analysis to identify risks and opportunities that may not be visible with traditional financial analysis alone.”

While ETFs are among the more transparent investment products on the market, the responsibility still falls on Canadian investors to assess whether a fund meets their values. Online tools such as Weapon Free Funds assess the amount of exposure an ETF has to gun and military companies, though that particular website does not include Canadian products.

Investors are becoming savvier as they do more research for do-it-yourself investing, and it’s important to be able to sift through the underlying holdings of an investment and assess its sector exposure, says Tammy Cash, Horizons ETFs Management Canada Inc.’s executive vice-president and head of marketing.

“Really immerse yourself in knowing what you’re holding, because what is marketed as ESG is a broad category, and what’s ESG to one person isn’t necessarily ESG to another,” she says. “Only the individual can determine where they place that priority.”

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