Divestment and Rational Expectations

Genocide in South Sudan. Ethnic cleansing in Myanmar. Political prisoners and purges in China, Iran and Venezuela. Continued Russian attacks in Ukraine. Human trafficking in Africa and Asia. Our world is sadly never free from state-sponsored atrocities. As we often remind readers, markets are cold-hearted and often rise in the face of localized human suffering. But people aren't cold-hearted! Many investors care deeply about human rights and other social issues. So what is a warm-hearted investor to do about companies that run afoul of their convictions and values?

Ultimately, it is a personal choice. I'm not here to tell you how to think or what to do. But one tactic championed by pundits, activists and advocates these days-divestment-is cloaked in myth. Understanding what divesting does-and doesn't-do can help make investors make more educated decisions.

Divestment, as the name implies, means not investing in any companies that are involved-directly or indirectly-in situations or activities you don't support. That might include Energy companies drilling for oil in South Sudan if you feel passionately about ending genocide. High-tech companies manufacturing in Malaysia, if human trafficking is your issue. Industrials and banks investing in Myanmar's burgeoning infrastructure development, if the strife faced by the Rohingya Muslims is your cause. Any Energy firm drilling for fossil fuels, if you're gunning for a green world.

For some, divestment is simply a matter of conscience-as in, "I don't even want to touch anything associated with X, I hate it so much and find it so morally reprehensible, it would be hypocritical to own even one share." If that is you, great-follow your convictions (but make sure you stay diversified!). Many institutional investors will also go this route, with bylaws mandating investments only in environmentally or socially responsible firms.

So where does divestment break down? When it morphs from a matter of pure personal conviction to an attempt to be an agent of change. As in, "if everyone sells this company, we can drive down the stock and put an end to (insert chosen cause/issue/practice here)!" Unfortunately, this isn't how markets work. Divestment won't foster the changes folks seek.

In socioeconomics, there is a concept called "voting with your wallet"-choosing which businesses to support or not support through your own economic activities. When I was a young lass, a certain clothing company printed t-shirts I considered racist and treated friends of mine in ways I believed to be racially discriminatory, so I never shopped there (and never will). Someone gave me a sweatshirt from them once, and I went in and haggled with the manager for half an hour to get them to take it back, explaining that my conscience meant more to me than their arbitrary return policy. (I won that fight.) I also know people who won't buy cosmetics tested on animals, coffee that isn't sourced at "fair trade" prices, snacks sold by food/tobacco conglomerates, goods made in certain nations or clothes made at third-world sweat shops. That is all "voting with your wallet," as it directly deprives these companies of revenue and possibly profit.

Divestment is different, though. Stocks and corporate bonds trade on secondary markets. Unless you have the option to buy at issuance, buying a stock or bond does not mean you are funding the company. The money you spend on that stock or bond doesn't go to the company-it goes to the investor trading those shares. To use a bad analogy, it is like buying a used good at a flea market. The original manufacturer never sees a dime. Divestment doesn't rob companies of funding.

It also won't drive the stock price down far enough to put the company out of business or goad them out of whatever practice you are trying to abolish. Take the very delicate example of South Sudan, where a few huge Chinese, Indian and Southeast Asian oil firms have large oil drilling interests. Many accuse these companies of indirectly supporting the South Sudanese government's reported atrocities against civilians, arguing the tax revenues they pay fund war crimes. Thus, the logic goes, if you divest and drive down the stock price, they'll have to cut costs and pull out of South Sudan, robbing the government of that ill-spent tax revenue.

Here is the problem with this thesis: These are all huge foreign companies, with most of their shares traded on their own domestic markets. In China's case, most shares are owned by the Communist Party elite. US investors can access only American Depository Receipts (ADRs-shares created to trade on the US exchange), which is a limited universe. Tens of thousands of shares of an ADR might trade daily-compared to tens of millions traded on the domestic market. The ADR activity is a drop in the bucket, not nearly enough to impact the price. Plus, for every buyer, there is a seller. For everyone selling a share to divest and foment change, an unaware or less convicted investor could buy. If the price moved down at all, others could easily see it as happily discounted, snap it up, and bid the price back up. Divesting those firms won't change South Sudanese policy any more than selling stock of every firm operating in the US would change US policy. The market is too powerful for that.

The same applies to human trafficking, fossil fuels and other issues. Heck, sometimes people can trade on the same principles but act very differently. Someone divesting an Energy firm that deals in natural gas because fossil fuels aren't green might sell to someone else trying to support natural gas because it is the cleanest-burning fossil fuel. The market is a gigantic, diverse blob, composed of millions upon millions of competing interests.

With very few exceptions, for businesses to change objectionable practices, those practices would have to become unprofitable. Not always! Some firms will make changes on principle, like those refusing to do business in South Africa during Apartheid or those sourcing fair-trade goods only. It happens. But for most, the bottom line determines strategy. For example, if oil prices get lower and stay there, perhaps firms will find it no longer makes sense to drill in South Sudan, and they'll pull out. Perhaps supporting fracking is the best way to make an economic vote against the atrocities in South Sudan.

Again, go where your head, heart, values and convictions lead you. Support the causes close to your heart. Raise awareness. Volunteer. Write to your Congressperson. But when it comes to portfolio choices, make sure your expectations are realistic.