Socially Irresponsible Investing

Guns. Half of your investment pool will be for banning guns and the other half will adamantly recite the Constitution’s given second amendment. Let’s throw abortion into this pot, too. Just watch presidential debates and you’ll see that just as with guns, the country is hugely divided on abortion. Which half is your socially responsible fund is trying to please, those who defend the Constitution and individual rights, or those who would keep people from hurting themselves?

Big oil. Oil and especially big oil is hated. Global warming is bad, thus big oil is bad. Except that the internal combustion engine has brought billions of people out of poverty and has been responsible for tremendous improvements in the quality of life globally. A third of the U.S. workforce still labored farms at the opening of the 20th century; now, largely thanks to oil (gasoline), only 3% of the employed population works in agriculture. Don’t want big oil get your capital? Less capital means higher oil prices, and thus people on food stamps will have less money left for groceries. Just be aware of this.

Green energy is great! No pollution or global warming. This must be socially responsible investing. Well, except if you love birds and don’t want them to be massacred by windmills.

Defense companies. Would America and the world be better off if the U.S. spent 1% of GDP instead of 3% on defense? Is our defense industry really an offense industry? I’ll let you ponder and debate these points. But I hope you see the arguments for both sides and that most people will disagree on this topic.

Pawn shops. This one is my favorite. I love it when rich, privileged people feel bad for poor people and are outraged that pawnshops charge 200% interest a year. They try to run pawnshops out of business and in doing so hurt the people they were so compassionately trying to help.

Pawn shops are the second oldest profession, because banks simply cannot make money giving out $50 loans and charging a 10% or even 20% interest rate. For anyone reading this, $50 or $100 is a trivial amount. In the very worst case we could borrow it from a family member or friend, put it on a credit card, or utilize our bank line of credit. But what if you don’t have a stable job or you make so little money that the bank won’t touch you? What if you don’t have relatives who can help you? What if you need $100 so you can buy groceries or pay the electric bill or pay a court fine?

Yes, a court fine.

I’ve seen a 28-year-old women sent to jail to serve seven days because she did not have $700 to pay a court fine. One day in jail per $100 of fine. True story. The irony was that $300 of the $700 was late/nonpayment fees. Yes, annualize that. Do you think she might have been better off if she could borrow this money at 200% a year?

Child labor. This one should be a slam dunk. Child labor is bad, right? Well, what if assembling widgets or sewing t-shirts is the only way you can keep your family from going hungry? What if you live in a country where to stay alive everybody in the family has to work? Where going to school (if there is one) means you starve. By employing these kids, are you taking advantage of them or saving them from starvation? Stop allocating money to countries that allow child labor and you may to the malnutrition and even death of millions of people.

I am writing this in a nicely air-conditioned single-family home. My kids bring up child labor laws when I ask them to wash dishes. They get the best education my tax money can buy. Of course, I don’t want them to work in a factory making t-shirts. But it is so easy for us to impute our values to other countries where the economic situation may be so much different. We do this all the time.

What about American blue chips like IBM or Walmart? I had a Jewish client who told me to never, ever buy him IBM because IBM made counting machines that were sold to the Nazis and used in concentration camps. For the bulk of the population IBM is a socially responsible company; however, half of his family was killed by Nazis. Who am I to argue or to judge him? Should IBM be excluded from the pool of socially responsible companies?

Walmart. The biggest employer in the U.S. They ruin small towns and don’t pay their employees fair wages – at least that’s the “socially responsible” argument. I had clients who were outraged of my “lack of ethics” when I bought them Walmart stock.

I can keep going. We can talk about pharmaceutical companies and the prices they charge. And Coke, Pepsi, and McDonalds. Are they responsible for the U.S. obesity and diabetes epidemics that we are exporting globally? Do they kill more or less people than Philip Morris? Are their products actually even worse for you because there’s no warning label like we find stamped on each pack of cigarettes?

Child pornography, slavery, drug and human trafficking – there are a few absolutes that all of us will agree are immoral and socially irresponsible. There is no point of setting up a socially responsible fund that avoids those; our laws have taken care of them. Outside of these few exceptions, though, we can’t agree collectively (key word) what “socially responsible” means. Society comprises individuals, each of whom has different values that we inherited from our parents through dinner-table discussions and accumulated from own experiences, just as we did our political and religious views.

When you hire someone to perform socially responsible investing for you, you are making an assumption that this person shares the same social values as you. You may get lucky. But it is impossible to practice socially responsible investing on a collective basis. Asking a portfolio manager who manages an investment pool (mutual fund or hedge fund) to be social responsible is basically asking him or her to make a decision that every member of the pool will agree is socially responsible. Good luck!

P.S. At IMA, incidentally, we have the luxury of practicing socially responsible investing by asking clients, “Are there any types of stocks you’d like to avoid?” The most common answer we get is, “Yes, the ones that decline and never come back up.” Occasionally we get a more specific request – don’t buy us this or that. We don’t judge.

Vitaliy Katsenelson is chief investment officer at Investment Management Associates in Denver, Colo. He is the author of “Active Value Investing” (Wiley) and “The Little Book of Sideways Markets” (Wiley). Read more on Katsenelson’s Contrarian Edge blog.

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