An Assessment of Terrorism-Related Investing Strategies

Do terrorism-related investing strategies lead to superior investment performance? This study evaluates the risks and returns to two different terrorism-related investment strategies in the U.S. markets over the period from 1994-2006. The first strategy evaluates a sub-portfolio of S&P 500 stocks constructed on the basis of terrorism-related risk scores that measure their operations in countries with a high incidence of terrorism-related activity. The second strategy evaluates a 'terror-free' sub-portfolio of S&P 500 stocks in which stocks are screened if they have operations in countries that the U.S. Department of State has designated as state-sponsors of terrorism. I find that the terrorism-related risk exposure portfolio would have earned, on average, an economically small and statistically insignificant 16 basis point premium per month with a tracking error of 2.8% per month and that of the terror-free portfolio an even smaller -1.6 basis point premium per month with a tracking error of 25 basis points per month. Return attribution analysis using a multi-factor model uncovers interesting differences in systematic exposures to market risks, and factors related to size, market-to-book ratios and momentum.