Sign of the Times

Research: Can you tell us a little about CSAG?

Pener: Conflict Securities Advisory Group (conflictsecurities.com) is a private, impartial information provider that maintains the world's only comprehensive database of U.S. and foreign publicly traded firms that have current or recent business ties to Iran, Sudan, Syria and North Korea: all countries that have been designated by the U.S. State Department as state sponsors of terrorism. This Global Security Risk Monitor is an online subscription database. Clients include the Securities and Exchange Commission, the State Department, dozens of leading asset management firms, the states of Missouri and Arizona, the Comptroller of New York City (who is the sole fiduciary for the city's $85 billion public pension systems) — and Roosevelt Investment Group, the first firm in the country to offer "terror-free" separate accounts as well as the world's first "terror-free" mutual fund, the Roosevelt Anti-Terror Multi-Cap Fund (BULLX).

What is "terror-free" investing, anyway?

Like other categories of values-based or socially responsible investing, "terror-free" investing is a screening strategy whereby the investor excludes companies that engage in business activities with which the investor disagrees — in this case, companies whose activities benefit governments such as those in Tehran and Pyongyang. Some people choose not to invest in so-called "sin stocks" (e.g., gambling, alcohol, etc.). With "terror-free" investing, the investor is avoiding companies that he, she or the institution feel are engaged in business activities that are inimical to U.S. security interests.

Put simply, "terror-free" investing is when an investor chooses not to invest in some or all of the roughly 450 companies that CSAG identifies as having business in or with terrorist-sponsoring states.

How did the idea emerge and how did CSAG get involved?

It is difficult to pinpoint the exact genesis of "terror-free" investing. In 2004, investors began approaching CSAG in the hopes of excluding companies with ties to terrorist-sponsoring states from their portfolios. Prior to that, our clients were primarily using the Monitor as a risk-assessment tool. Following a 60 Minutes segment in 2004 entitled "Doing Business with the Enemy," in which CSAG was featured, there was an uptick in inquiries concerning the use of our data as a screen.

While CSAG is an impartial data provider (and as such does not take a position concerning the use of our data), it became clear that our clients were increasingly seeking to excise and exclude some or all of the companies we identify from their investment portfolios for personal, ethical or moral reasons. Our board decided to respond to this demand by "productizing" our data — that is, we began to pursue strategic partnerships that now allow both institutional and individual investors to use our data as a screen, should they so choose. These are the so-called "terror-free" products and services.

The Roosevelt Investment Group approached us during this period with the idea of screening their mutual fund and being certified by CSAG as "terror-free." The concept picked up steam from there.

Which countries and companies are screened out?

That is a question best directed to each fiduciary implementing a "terror-free" screen. The Roosevelt Anti-Terror fund screens out companies with any business tie in any of the countries. Other investors have focused on Sudan due to the genocide in that country. Missouri Treasurer Sarah Steelman developed a more nuanced screen [see profile on page 47]. Currently, "terror-free" investing is trending toward screening out companies with active business ties to these countries which are non-humanitarian in nature.

To answer your question another way, we primarily service clients and their managers by helping implement the screen as opposed to designing the policy.

How do these portfolios stack up on a performance basis?

So far, so good. Last year, the Missouri Investment Trust (MIT) became the first public fund in the country to establish a "terror-free" policy. Working with CSAG and its manager, State Street Global Advisors, MIT undertook a rigorous back-testing exercise in which it found that the impact on performance of a "terror-free" overlay from 2001-2005 was de minimis. In fact, over that period, the screened portfolio would have outperformed the index against which the screen was run.

Even more exciting from our perspective was the effectiveness of the streamlined, non-disruptive implementation process CSAG designed and executed. Specifically, State Street excluded some 10 to 20 "noncompliant" companies from its MSCI-based index, rebalanced and, in less than 30 days, MIT had what many argued could not be done: an international portfolio that excludes companies that do business with governments that sponsor terror.

Back to your question, the MIT screened portfolio has outperformed its EAFE benchmark over the first two quarters. As of now, the "terror- free" screen is set to more than pay for itself in terms of basis-point gains versus its benchmark. These results shouldn't be terribly surprising. We're talking about screening some 200 to 400 companies out of a global universe of 20,000. An average portfolio may contain, what, five or 10 that need to come out? And unlike some SRI categories that wipe out an entire industry (e.g., tobacco), here "non-compliant" companies can easily be replaced by peers. As a Wall Street executive recently said, "terror-free" investing is a matter of philosophy, not implementation.

With other "social" portfolios, there's the screening component but also a shareholder-activism aspect. Is there a structure here for voting proxies?

There's certainly the structure for it. In fact, this is the approach that the Comptroller of New York City, William Thompson, has taken with the help of the Monitor. His office issued shareholder resolutions with a number of U.S. companies that were doing business with terrorist-sponsoring states via overseas subsidiaries. After some initial opposition, we understand that many of these companies withdrew their activities in these countries. That said, the proxy dimension is quite nascent at this stage.

How can advisors explore terror-free investing for their clients?

We'd of course be pleased to discuss this issue with advisors.

Do you have any insight into possible tactics that an advisor could use to integrate terror-free solutions into his or her marketing strategy?

There is tremendous demand for this information at this stage. What's clearly lacking are products and services. Where are the "terror-free" mutual funds, indices, tabs on "socially-responsible" retail screening products? Where are the advisors asking their management for a "terror-free" capability to service clients?

Five years from now, terror-free products will be boilerplate, but today, there is a glaring hole in the market at the retail advisor level. My "insight" is that advisors should consider how many of their clients would invest "terror-free" if given the option without sacrificing returns. Then consider whether someone else's clients would move their assets to your firm if you offered them screened products and services. My recommendation is this: Tell your managers to develop "terror-free" investment products and services that will differentiate you from your competitors.

What do advisors need to be telling their clients about the current geopolitical environment and how to invest in it?

Buckle up. There may be some turbulence ahead.

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Robert Scott Martin is a New York-based contributing editor of Research.