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The ESG Risk of Investing in Facebook Now

A look at 10 funds hit hard by Facebook’s data controversy

Syl Flood

 

If you were going to hear from your clients about their exposure to Facebook, you very likely would have heard from them by now. But there are some things to consider as Congress examines the company’s practices and policies this week.

Through April 5, Facebook stock is down 16% since the news about Cambridge Analytica first broke. (However, Morningstar’s analyst who covers the company thinks that this presents a buying opportunity.)

Loosely governed private data, the root cause of Facebook’s current trouble, is among the major environmental, social, and governance (ESG) risks for 2018 highlighted in a recent report from Sustainalytics, Morningstar's ESG-research partner.

The Sustainalytics report characterizes the broader risk in the software and services industry as “antitrust in the digital age.” That is, the global tech superpowers are at risk of being regulated due to concerns not only about data privacy, but pricing power and anti-competitive activity. So let's take a closer look at what financial advisors may want to know about these risks.

Companies with access to user data carry ESG risks

Companies have unprecedented access to personal data through software as a service (SaaS) models. The data gathered through these platforms are monetized through targeted advertising and other means. Consumers sometimes wonder how Google and Facebook can have such thriving businesses when their services are “free.” The answer is that the consumer is the product. The consumer trades some of his or her privacy for the services these networks offer to paying, corporate customers.

Many—but not all—investors have overlooked the privacy issues lurking in the background while enjoying the stock’s multiyear run-up. As a group, such risks are referred to as governance risks, representing the “G” in ESG.

For Facebook, data privacy is the preeminent governance risk now. But all companies must deal with such risks, including CEO compensation, conflicts of interest, shareholder engagement, and crisis preparedness. Today, governance is increasingly a core aspect of many portfolio managers’ investing processes, though the trend is more prevalent in Europe than in the United States, BlackRock notwithstanding.

What impact does investing in Facebook have on your clients?

If you haven’t had a chance to measure the impact that this data scandal has had on clients investing in Facebook, the following table should help. We used Morningstar Direct to identify the largest actively managed U.S. diversified equity funds that own Facebook.

Silver-rated Fidelity Contrafund FCNTX, a mainstay of 401(k) plans and variable annuity policies, had 6.95% of assets in Facebook as of the end of January. This is a large position in one company for any fund, much less the second-largest actively managed diversified U.S. equity fund in the market. The fund’s return has suffered accordingly, losing 5.60% through April 4.

But Contrafund shareholders have little to complain about. Manager Will Danoff first bought Facebook before its May 2012 IPO. A 3-million-share position in the B-class of the stock first appears in the fund’s portfolio in April 2011, at $8 per share. Yes, $8. Per. Share.

Bronze-rated American Funds Growth Fund of America AGTHX, the largest actively managed U.S. equity fund, had a market weighting on Facebook: It held 1.80% of assets in the stock, while Facebook represents 1.83% of the bellwether S&P 500.

Notably, several of the largest, widely-owned actively managed funds don’t own any Facebook shares, according to their mostly recently disclosed portfolio holdings. These include Gold-rated American Funds’ Washington Mutual AWSHX and Silver-rated Investment Company of America AIVSX, and Gold-rated Dodge & Cox Stock DODGX.

Mitigating client exposure to ESG risk

Facebook’s data controversy is an opportunity to learn about other ESG risks that might be lurking in client portfolios—to prepare your clients for some of those risks becoming reality. While the Facebook controversy will eventually resolve itself for better or worse, other risks in your clients’ portfolios could also be headed for a tipping point.

This research was conducted using Morningstar Direct. If you’re a user, you have access. If not, take a free trial.

Learn more from Sustainalytics’ full report “10 for 2018: ESG Risks On The Horizon.”

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Sustainalytics is a leading global provider of ESG research and ratings. The firm’s ESG analytics underpin the Morningstar Sustainability Rating™ for funds.

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