Just as the South Africa disinvestment movement decades ago caused companies to terminate operations there, the theory is that terror-free investing will cause companies to stop doing business in or with countries considered to be state sponsors of terror.
The Missouri State Treasurer gave birth to the movement in June 2006 when she set up a terror-free investment fund within the Missouri Investment Trust. Provisions are being made in Missouri for college 529 savings plans to have a terror-free investment option.
Since that time several other states have begun exploring terrorism-free investment mandates for their state agencies. Yet some say it is not for states to decide such issues, preferring to defer to federal decisions on the matter. Portfolio managers and plan administrators say that as fiduciaries they cannot take on social causes unless the are imposed on them by mandate. The movement is gaining ground, but is still young with a not entirely certain future.
For investors, the basic questions are: “Do I want to own stock in companies that do business with countries that sponsor terrorism?” “Do I want my money to help pay for the bullets, bombs or poisons that may one day kill me, my family or others?”
Conceptually, the idea is simple, but practically implementation is difficult. How would one establish a method and rules for such an investment approach? How would one do the research to develop a list of companies to exclude from investment?
It is likely that a terror-free portfolio could perform just as well as an unscreened portfolio. We have not tested that assumption in this instance, but have previously tested other socially screened portfolios against their unscreened index benchmarks and found ample return opportunity.
As is the case with most socially screened investments, certain arbitrary definitions and limits need to be established to make the portfolio management job feasible within reasonable costs and timeframes, and to reach clear conclusions as to what is permitted and what is prohibited for investment.
In the U.S., so far, the working definitions for terror-free investing have been evolving through legislation and government agency decisions. The U.S. State Department has designated five countries as providing state support for terrorism: North Korea, Iran, Sudan, Syria and Cuba. The SEC formed the Office of Global Security Risk in 2001 to review filings of companies trading on U.S. exchanges to identify business connections with countries on the State Department terror list.
The list of 90+ companies recently published by the SEC that have business in countries designated as sponsoring terrorism is provided in the chart below:
Putting Teeth into the Laws:
Senator Chris Dodd of Connecticut, Chairman of the Senate Banking, Housing and Urban Affairs Committee, has made a point of saying that we must get much tougher on terrorism through financial controls as well as other means.
Congress has been working on legislation that would levy tough sanctions against companies doing business directly, or to some degree indirectly, with designated terror supporting states, and may involve seizure of the U.S. assets of those companies, including their affiliated companies; and nullification of U.S. contracts with those violating companies.
Another piece of legislation under consideration would eliminate current exemptions for major oil companies doing business in restricted countries.
Kiplinger’s pointed out that:
The law could also be applied to foreign banks, insurers or shippers that are part of a supply chain for Iran. Companies in Germany, the United Arab Emirates, China, Italy, France, South Korea and Russia are most likely to have business links to Iran.
Law of Unintended Consequences:
If the sanctions legislation passes, as we think it will in some form, there will be confusion in the securities markets until the regulations are promulgated and the administration of them is clear in practice. The confusion will manifest itself as extra volatility in prices of stocks that may or may not come under the hammer of the law.
The legislation will contain loopholes and unexpected problems. Unintended consequences of implementation will create additional administrative exceptions. Until it is all settled in terms of administrative interpretation of the legislation, extra volatility will persist in potentially impacted stocks. Those thought to be OK may experience multiple expansion as a result.
Implementation problems will arise because the world is a totally interconnected system and it will be difficult to impossible to create clear lines of demarcation on what is trading with the enemy and what is not.
Consider questions such as these:
Will major oil companies be required to abandon billions of dollars of long established properties and operations in designated states to avoid seizure of U.S. assets — putting them in a lose-lose situation? Will a major consumer staples company have its U.S. headquarters building seized by U.S. agents because it cannot prevent the flow of its soap and toothpaste into designated terrorist countries? Will a major pharmaceutical company selling proprietary drugs that save children’s lives in Iran be forced to stop to protect its U.S. franchise? Will the U.S. effectively encourage terrorist states to manufacture their own generic versions of needed drugs that they might otherwise have avoided out of respect for patent rights? If a company is a parts or material supplier to a company that in turn does business with a terrorist state, will that supplier be sanctioned too? How many levels in the supply chain would be implicated? Would a utility company supplying energy to a violating company be legally exposed to penalties if they knew the company was on a government terror list? Would they have the authority to refuse to provide electricity or gas without breaking other laws and contracts? Would a country like France, that has long standing business connections with Iran, stand idly by as the French economy was damaged by the impact of the U.S. laws on key French companies such as TOTAL (TOT)? China has long term energy supply relationships with Iran. If delisting were a penalty, would Petro China (PTR) be delisted in the U.S? How would U.S. investors in delisted companies exit their positions? Petrobras (PBR) has Iran connections and they are the principal exporters of Brazilian ethanol. Will Bush’s recent plans to collaborate with Brazil on ethanol development be torpedoed because Petrobras is in Iran? Will the S&P500 energy sector (XLE) be modified to eliminate Connoco Philips which is on the list of those doing business with states sponsoring terrorism? Will we now have the “S&P 500 ex Terror index”? Which index will be the benchmark for state pension plans – the original S&P 500 or the Terror-Free index? Will mutual funds be taxed or regulated differently if they include companies on the terror list than those that exclude those companies?
The Fund's Problem:
It is very difficult to avoid owning companies on the terror list if an investor uses funds, as most retail investors do. The only effective way to avoid owning terror list stocks is to manage an individual stock portfolio, or to buy a specialist fund that represents itself as terror-free. Only one such retail fund exists today, the The Roosevelt Anti-Terror Multi-Cap Fund (formerly the Bull Moose Growth Fund), symbol BULLX.
Will the government take steps to require mutual funds, pension plans, endowments and other pooled investments to divest of companies on the terror list? If they did, would they step on the secret and hallowed ground of the hedge fund industry?
There are some groups pressing for voluntary and state mandated divestment by public pension funds, as well as federal requirements for mutual funds and endowments to divest. Others are pushing back with arguments that voluntary divestment will not work and that state regulations have been found by some courts to be assumption of foreign policy decisions that are outside of the scope of authority for states. Still others say that plan administrators do not have the authority to subordinate fiduciary obligations to maximize return to social causes. Where they all seem to agree is that if anything comprehensive is to be accomplished with respect to pensions, endowments, mutual funds and other regulated investment funds, it will have to come from federal legislation and regulation.
The Oil Problem:
The concept of not consorting with the enemy via commerce is a good one in principle, but how effective will it actually be at increasing security? Take the case of oil.
The money we all pay for gasoline and heating oil may do more to finance governments supporting terrorism, even North Korea indirectly, than the business connections terror-free investing is meant to interupt?
At the same time, how much oil money in the hands of black-listed countries comes back to public companies in the form of share purchases and bond purchases? Will that become a future area of additional scrutiny?
Foreign Policy Problem:
To the extent that security is the issue, we face the potential problem that some countries may deserve to be on the black-list but are not for strategic reasons, while others may be on the list that no longer need to be there?
Bureaucracy and Politics Driven Process:
If terror-free investing is important to you for your account, then you must keep in mind that governments and their agencies behave bureaucratically and politically, and that may not be the same as behaving in ways that will meet your information objectives.
Case in point: When we began looking at terror-free investing in March of 2007, we contacted the SEC Office of Global Security Risk to request a copy of the list of companies they had identified as working in counties that the State Department designated as supporting terrorism. We were told flatly that the data was private between the companies and the SEC and was not available to the public. When asked how that was supposed to help protect investors, which is part of the SEC mission, they had no answer.
Fortunately, Senator Dodd of Connecticut took initiative and wrote to the SEC in May asking them to step up their efforts to help investors understand Global Security Risk. The list of companies subsequently became available online.
Government works in its own ways on its own timescale. It cannot be relied upon to present all the relevant facts to investors when and as they need them. You need to do your own research in addition to that supplied by the government.
This article is not about politics. We don’t want to digress from the basic issues of investing, except to say that if you want a terror-free portfolio that meets your concerns, you need to decide what that means and then carefully consider whether government lists are driven by the same set of issues as your desire to keep your hard earned money from aiding the enemy. Terror-free investing to be effective for your purposes may require a more complete and careful review of countries and companies to satisfy your sense of security. Government lists are helpful, but may not be sufficient. However, they are a good place to begin any terror-free research and screening efforts.
You can access the SEC list of companies, the SEC comments about each company and links to the relevant company SEC filings here.
Disclosure: Author owns Conoco Phillips (COP) and may own other stocks on the list indirectly through funds, such as PetroBras (PBR) owned indirectly through the Brazil ETF (EWZ), or various other companies owned indirectly through the MSCI EAFE index ETF (EFA) or other funds owned by the author.