Bi-Weekly Geopolitical Report – Sanctions as an Investment Risk (2/24/2025)

 In an increasingly confrontational world, you can add sanctions to what seems like an expanding field of investment risks. Confluence Chief Market Strategist Patrick Fearon-Hernandez joins Phil Adler to help investors identify and respond to sanctions risk. 

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Podcasts from Confluence Investment Management LLC, featuring the periodic Confluence of Ideas series, as well as two bi-weekly series: the Asset Allocation Bi-Weekly and the Bi-Weekly Geopolitical Report (new episodes posted on alternating Mondays).

Phil Adler: 00:07

Welcome to the Confluence Investment Management Bi-Weekly Geopolitical Report for 02/24/2025. I'm Phil Adler. In an increasingly confrontational world, you can add sanctions to what seems like an expanding field of investment risks. Confluence chief market strategist Patrick Fearon Hernandez joins us today to help investors identify and respond to sanctions risk. Patrick, everybody is focused today on how tariffs might impact investment strategy.

Phil Adler: 00:39

Have we forgotten about sanctions?

Patrick Fearon-Hernandez: 00:42

Hi, Phil. Thanks for having me on the program. And to answer your question, yes, everyone has been focused on president Trump's tariff policies ever since the election, but people seem to have forgotten all the sanctions that The US has put in place in recent years. Those sanctions remain in place, and more have been added in just the last few weeks. More important, even if Trump imposes lots of new tariffs, his administration also could potentially add a lot more sanctions either against whole countries, against particular companies, and even against individuals overseas.

Patrick Fearon-Hernandez: 01:15

So it's important to keep this in mind.

Phil Adler: 01:18

How might ignoring the risk of sanctions impact our investments?

Patrick Fearon-Hernandez: 01:22

Well, that's exactly why we wrote this article. For US Investors, it's important to remember that The US has imposed a wide variety of sanctions, and they often come out of the blue. They can prevent a US individual investment fund or company from all kinds of transactions with other countries or other entities and individuals associated with a foreign country. They can even punish those foreign entities or individuals for doing things outside The US that are inimical to US national security or foreign policy. A key problem is that US Investors could wake up some morning and find that they can't sell a particular investment or that a company they've invested in has lost a major market.

Patrick Fearon-Hernandez: 02:08

Sanctions mean the possibility of a sudden freeze on one's assets. So that's why investors need to pay attention to the risk of sanctions.

Phil Adler: 02:16

Well, when we think of sanctions, what might come to mind first for many people are the sanctions against Russia instituted by The US because of the Ukraine war. How have they worked?

Patrick Fearon-Hernandez: 02:29

Well, there actually have been many, many different sanctions imposed on Russia, both by The US, by the Europeans, and sometimes by both together. Many of the sanctions have banned transactions with Russian individuals, companies, government entities, or even whole industries such as energy. Overall, their success has been hit or miss. Some sanctions such as freezing Russia's foreign currency reserves held in the West have been extremely successful. For example, we think that's a key reason for today's central banks that are buying so much gold and driving gold prices up to record levels.

Patrick Fearon-Hernandez: 03:06

On the other hand, Russia and other actors have found loopholes or other ways to get around a lot of the other sanctions, especially in oil shipping. But even though some sanctions have been successful and others not, law abiding investors and investment managers have certainly been impacted.

Phil Adler: 03:24

Patrick, you point out that there are many kinds of sanctions. Tell us some of the key differences that we should remember.

Patrick Fearon-Hernandez: 03:32

Well, one distinction that we emphasize is the difference between comprehensive sanctions and targeted sanctions. A comprehensive sanction is applied to an entire foreign country. For example, The US maintains comprehensive sanctions barring US persons from virtually all transactions with the country's citizens or residents of Iran, Cuba, North Korea, and Russian controlled parts of Crimea. The US also maintains targeted sanctions that bar US persons from transactions with specific foreign entities, individuals, or activities. Targeted sanctions are often referred to as list based since the targeted entities or activities only become subject to the sanction when they've been put on a special list.

Patrick Fearon-Hernandez: 04:21

Believe it or not, Phil, there are currently thousands of foreign individuals and entities on US sanctions lists. Now, another key distinction that we make is between primary and secondary sanctions. A primary sanction generally imposes criminal or civil liability on US persons for transacting with sanctioned foreign entities. In contrast, a secondary sanction aims to stop or deter specified transaction between non US persons, even if those transactions occur outside The US and have no direct connection with The US, the penalty for violating a secondary sanction is generally to deny the non US person from certain privileges related to The US, such as access to The US financial system. Now, based on this discussion, I think you can see that there are lots of different kinds of sanctions that could trip up an investor.

Patrick Fearon-Hernandez: 05:17

But also Phil, I want to emphasize that we aren't lawyers. So our discussion of US sanctions law here is merely a summary and shouldn't be taken as authoritative.

Phil Adler: 05:29

Patrick, could you give us a couple of quick examples of of the different kinds of sanctions?

Patrick Fearon-Hernandez: 05:34

Sure. Again, the best example of a comprehensive sanction is probably the broadband on transacting with Cuba to include travel to the island. An example of, targeted sanctions would include the entity list of Chinese companies that support Beijing's military. The US sanctions against Cuba are primary since they apply to US citizens. They also apply to entities located in The US and entities organized in The US and even non US entities owned or controlled by US persons.

Patrick Fearon-Hernandez: 06:07

In an example of a secondary sanction, The US will punish foreign entities that engage in some transactions with North Korea, such as closing off their access to The US financial system.

Phil Adler: 06:21

Well, how does Confluence go about identifying investments that might be prone to sanctions risk?

Patrick Fearon-Hernandez: 06:29

Well, for us, this is actually a work in process in that we're trying to improve and rationalize how we identify sanctions risks. We're currently developing an approach that systematically develops a sanctions risk score for various holdings or potential holdings in our portfolios. We've identified several metrics or indicators that we think correlate with a higher level of sanctions risk. The idea will be to keep track of our holdings sanction risk scores and be especially careful in monitoring developments for those holdings that seem to be at high risk.

Phil Adler: 07:06

Give us an example, Patrick, of how the metric used by Confluence can measure an investment's sanctions risk.

Patrick Fearon-Hernandez: 07:14

Well, one metric is our block analysis in which we systematically determine whether a country is in The US geopolitical and economic block, the Chinese block, or a few intermediate blocks. Now, given that the geopolitical tensions and large number of existing sanctions between The US and Chinese blocs, we would score any company associated with a China bloc country as relatively high risk. If the firm is actually organized based or mostly active in a China block country, we would score it especially high risk in terms of sanctions. But if it merely sells into a China block country or is otherwise only peripherally connected with it, then we would assign it a lower sanctions risk.

Phil Adler: 08:03

Well, an investor might think, well, I can avoid this risk entirely by simply not investing in foreign companies or funds. Is this a reasonable strategy?

Patrick Fearon-Hernandez: 08:14

No. We think that's going overboard. After all, a huge number of firms around the world would potentially be subject to sanctions. So an investor would probably be losing out on many good opportunities by taking that broad approach. Even if a country or a company is at risk of sanctions, the sanctions might never come.

Patrick Fearon-Hernandez: 08:33

We think the better approach is to think systematically about the sanctions risk of any particular company or country and make a judgment call as to whether the opportunity outweighs the risk. It would involve the kind of judgment calls that investors need to make on lots of different dimensions.

Phil Adler: 08:51

I guess the bottom line is that the investor should make sure that the firm that advises or manages his or her assets has a discipline to identify sanctions risk.

Patrick Fearon-Hernandez: 09:04

That would certainly help. And that's why I think we at Confluence are in a good position to manage sanctions risks. As I mentioned before, our unique groundbreaking block analysis highlights an especially important source of sanctions risk for investments. And our macro analysis group is especially focused on understanding the geopolitical, military, economic, and technological factors that can lead to international tensions and sanctions.

Phil Adler: 09:33

What's your advice for the individual active investor?

Patrick Fearon-Hernandez: 09:38

Well, as global geopolitical tensions increase, we think investors should favor managers who have some expertise in geopolitical or other big global risks. And even if someone is investing on their own, we would encourage them to pay close attention to the ebb and flow of geopolitical tensions. Of course, we write about those issues all the time in our daily investment comment, our biweekly geopolitical report, and other publications, all of which are available on our website. We encourage people to follow our analysis there.

Phil Adler: 10:11

Patrick, finally, you mentioned earlier the potential for more sanctions, but do you expect more sanctions as as well as tariffs instituted by The US in the days ahead?

Patrick Fearon-Hernandez: 10:23

Well, Phil, what I suspect is that in the near term, we'll hear more about tariffs than sanctions. However, since sanctions can be an effective tool in international relations, we think new sanctions on a range of other countries and foreign entities or individuals could still come at any time. This is a risk that hasn't gone away, so we think investors should be prepared for it.

Phil Adler: 10:47

Thank you, Patrick. This week's report is titled Sanctions as an Investment Risk, and you can find a link to the written report on the Confluence web page, confluenceinvestment.com. This written report does include tables that present current global geopolitical and economic blocks, as well as countries that are already under comprehensive US sanctions. And you'll also find a simple scoring rubric for sanctions risk. Today's discussion is based upon sources and data believed to be accurate and reliable.

Phil Adler: 11:18

Opinions and forward looking statements expressed are subject to change without notice. This information does not constitute a solicitation or an offer to buy or sell any security. Our audio engineer is Dane Stole. I'm Phil Adler.