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One of the mutual funds I invest in is indexed to the S&P/TSX Composite Index. I have a moral objection to one of the companies who makes up a small part of this index.

Hypothetically, is there a way for me to functionally exclude this single stock from my portfolio, while still investing in the mutual fund? Would short-selling an equivalent quantity of this stock be the right approach?

My hypothetical goal would be to morally own none of the stock, and I understand I would have to pay to achieve this.

  • How do you "morally" not own a part of whatever is owned by your mutual fund by short-selling one stock that you dislike outside the mutual fund? And what happens when you close the short or are forced to cover because your broker wants the shares back for some reason? – Dilip Sarwate May 15 '12 at 20:00
  • Dilip, I'm not sure that short-selling would accomplish this. But I'd own stocks I didn't want (in the mutual fund) and sell stocks I didn't own (short selling, I think). I realise that there's a downside to doing this. – ChrisInEdmonton May 16 '12 at 1:48
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    Chris, it is your idea, not mine, that short-selling the stock that you don't like relieves you of the odium of owning stock in that particular company. But if you own 10 shares through the mutual fund and short-sell 10 shares outside the fund, that does not relieve you of the ownership of the 10 shares inside the fund, and when you have to return the 10shares that you borrowed to sell short, you cannot take the ones inside the mutual fund and hand them to the lender; you have to buy them on the open market and return them to the lender, and for a short while, you own 20 shares! more – Dilip Sarwate May 16 '12 at 2:04
  • ...and when you have returned the 10 shares you shorted, you still own the 10 shares inside the mutual fund. What have you gained? – Dilip Sarwate May 16 '12 at 2:06
  • Ha. Owning twice as many shares as I currently do. Not a pleasant thought, even if only for a brief time. – ChrisInEdmonton May 16 '12 at 2:22
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Chris - you realize that when you buy a stock, the seller gets the money, not the company itself, unless of course, you bought IPO shares. And the amount you'd own would be such a small portion of the company, they don't know you exist.

As far as morals go, if you wish to avoid certain stocks for this reason, look at the Socially Responsible funds that are out there. There are also funds that are targeted to certain religions and avoid alcohol and tobacco. The other choice is to invest in individual stocks which for the small investor is very tough and expensive. You'll spend more money to avoid the shares than these very shares are worth.

Your proposal is interesting but impractical. In a portfolio of say $100K in the S&P, the bottom 400 stocks are disproportionately smaller amounts of money in those shares than the top 100. So we're talking $100 or less. You'd need to short 2 or 3 shares. Even at $1M in that fund, 20-30 shares shorted is pretty silly, no offense.

Why not 'do the math' and during the year you purchase the fund, donate the amount you own in the "bad" companies to charity.

And what littleadv said - that too.

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    While donating money might make both Chris's feel better, I still don't understand how that gets around the issue that the offensive shares are still owned by the mutual fund and so still owned in part by the investors in the mutual fund. – Dilip Sarwate May 16 '12 at 1:55
  • The company in question is in S&P/TSX60 and I may hold as many as 50 shares. The thing is, it's just this one company. I'm fine holding oil stocks, bank stocks, mining stocks, I just don't want to hold stock in a company which tried to extort money out of my wife's estate. You get +1 for 'do the math', though. A practical idea (doesn't stop me holding stock, but gives me a viable alternative). Also, interesting points on the socially responsible funds. Thanks. – ChrisInEdmonton May 16 '12 at 1:57
  • 50 shares of the fund or the offending stock? – JoeTaxpayer May 16 '12 at 2:49
  • @ChrisInEdmonton I'm quite skeptical that donating the money to charity is going to have equivalent effect as selling short. I'd expect that if many socially conscious people sold a stock short, it would have the effect of bringing down the price due to increased supply. JoeTaxpayer's claim that it's impractical is a logical error: the investor could likely focus on the "big fish". – glenviewjeff Jun 11 '13 at 22:01
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    It's impractical to do it precisely, and 100%. The volume held in indexes is so great that the few who would implement such a strategy of shorting are going to have zero effect. If only because those who feel strongly about these stocks are either buying the Socially Responsible funds, or individual stocks. – JoeTaxpayer Jun 12 '13 at 0:07
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Mutual funds invest according to their prospectus. If they declare that they match the investments to a certain index - then that's what they should do. If you don't want to be invested in a company that is part of that index, then don't invest in that fund.

Short-selling doesn't "exclude" your investment. You cannot sell your portion of the position in the fund to cover it.

Bottom line is that money has no smell. But if you want to avoid investing in a certain company and it is important to you - you should also avoid the funds that invest in it, and companies that own portions of it, and also probably the companies that buy their products or services. Otherwise, its just "nice talk" bigotry.

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    +1 for forcefully pointing out that short-selling does not exclude the investment. – Dilip Sarwate May 15 '12 at 20:20
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    littleadv, I've given you a +1, but I'd like if you could elaborate a bit on how short-selling wouldn't exclude my position. If my holdings in the mutual fund account for 10 shares, and I short 10 shares, I realise I'm actually borrowing the shares from someone else, but my net ownership would appear to be 0 in that specific company? The rest of your answer is easy to understand and well worth my +1. – ChrisInEdmonton May 16 '12 at 1:51
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    I'm not sure I follow... You have 1% of the ownership through the fund. That's not the shares you're using for your short, so you're borrowing some more. When the short is called - you cannot sell the 1% you own, so you end up with either gain or loss, but it doesn't change your ownership stake. – littleadv May 16 '12 at 1:56
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    littleadv, my reasoning is that I have +10 shares in the mutual fund and -10 shares by short selling. I realise they are not the SAME shares; I think short selling means I'm borrowing the broker's shares, certainly not my own. Is that correct? – ChrisInEdmonton May 16 '12 at 2:01
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    @ChrisInEdmonton yes, but then what's the point? You wanted to avoid ownership, and you haven't avoided it, instead you "own" twice as much: those that you own through the fund and those that you borrowed. – littleadv May 16 '12 at 6:17
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Owning a stock via a fund and selling it short simultaneously should have the same net financial effect as not owning the stock. This should work both for your personal finances as well as the impact of (not) owning the shares has on the stock's price.

To use an extreme example, suppose there are 4 million outstanding shares of Evil Oil Company. Suppose a group of concerned index fund investors owns 25% of the stock and sells short the same amount. They've borrowed someone else's 25% of the company and sold it to a third party. It should have the same effect as selling their own shares of the company, which they can't otherwise do. Now when 25% of the company's stock becomes available for purchase at market price, what happens to the stock? It falls, of course.

Regarding how it affects your own finances, suppose the stock price rises and the investors have to return the shares to the lender. They buy 1 million shares at market price, pushing the stock price up, give them back, and then sell another million shares short, subsequently pushing the stock price back down.

If enough people do this to effect the share price of a stock or asset class, the managers at the companies might be forced into behaving in a way that satisfies the investors. In your case, perhaps the company could issue a press release and fire the employee that tried to extort money from your wife's estate in order to win your investment business back. Okay, well maybe that's a stretch.

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    Except that if you own an index fund that's long the stock and you short sell it, you open yourself up to additional risk through your short position. This risk wouldn't exist if you didn't hold any position in the stock, so the net financial effect is not the same. Also, see the other answers and comments. – John Bensin Jun 11 '13 at 22:57
  • @JohnBensin exactly what risk is being introduced? From what I understand, you are removing risk of the undesired stock's stock price falling through the short sale. If the stock price rises, you would sell a proportional number of shares of the fund to cover the cost of the buy. – glenviewjeff Jun 12 '13 at 1:45
  • A) You may run a liquidity risk because the index fund might be much more liquid than the stock itself. B) You assume that your short selling or buying can affect the stock price, which is a big, and probably faulty assumption to make, especially for highly traded stocks. If you have enough money to influence the movement of a stock with a single trade, you'll either need to register that trade with the SEC, or you can use your Warren Buffet style influence to pressure the index fund in other ways. Also, see Joe's comment about the difficulty in doing this precisely. – John Bensin Jun 12 '13 at 2:20
  • @JohnBensin I used the extreme example to highlight the fact that if enough short selling (or other divesting) occurs, then the stock will certainly fall in value. I can't imagine any economist arguing with this principle. I'll edit the answer to indicate that it's a group of investors owning a 25% rather than an individual to eliminate the SEC part of the equation. And this is all about influence to me--not as an individual, but collective pressure to influence corporate change. – glenviewjeff Jun 12 '13 at 14:38
  • The idea that short selling leads to declines in stock prices in an unresolved issue in the literature, so I can certainly imagine economists arguing with that position. Short interest may increase near the same time as price declines, but correlation does not equal causation, hence the debate. My other point is that your extreme example isn't applicable to the OP's situation. Efforts to purchase 25% of the stock of a major company are far out of scope for a personal finance site. Also, the SEC would still notice an affiliated group of investors buying 25% of a stock. – John Bensin Jun 12 '13 at 14:58

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