An Assessment of Terrorism-Related Investing Strategies

Abstract

Do terrorism-related investing strategies generate abnormal returns or risks? Employing two strategies for U.S. stocks over the past decade, the author finds that this is not the case. The first strategy evaluates a subportfolio of S&P 500 stocks which is constructed based on a terrorism-related risk score that measures a company's degree of operations in countries with a high incidence of terrorism-related activity. The second strategy evaluates a “terror-free” portfolio of S&P 500 stocks that are screened based on the presence of a company's operations in countries deemed state sponsors of terrorism by the U.S. Department of State. The author finds that the terrorism-related risk exposure portfolio would have earned, on average, an economically small and statistically insignificant 16 bps premium per month with a tracking error of 2.8% per month and the terror-free portfolio would have earned an even smaller –1.6 bps premium per month with a tracking error of 25 bps per month. Return attribution analysis using a multifactor model uncovers interesting differences in systematic exposures to market risks and factors related to size, market-to-book ratios, and momentum.

TOPICS: Portfolio construction, risk management, ESG investing