Business Intelligence

Is Sharia Compliant Investment Worth it?

Aberdeen Islamic Asset Management Sdn Bhd is promoting the ethical and financial benefits of Sharia-compliant investment, which have more in common with SRI than most mainstream investors realise.


Industry perceptions

Every single investment is a leap of faith. For many choosing to invest in Sharia-compliant products, that is especially true given their religious convictions. In recent years, there has been a boom in demand for both equities and fixed income, such as sukuk, and the profile of Sharia-compliant products has risen. However, misperceptions remain.

First, it is often thought that performance will suffer in Sharia-compliant investments, owing to their religious component, which imposes restrictions on what securities investors may buy. Second, a commonly held belief is that Sharia-compliant investments are only really for Muslims and therefore irrelevant for mainstream investors looking to build genuinely diversified portfolios. Last, managers of Sharia-compliant funds are sometimes deemed to lack not only sufficient financial expertise, but also knowledge relating to Islamic practices and Sharia law.

To understand fully the advantages of Sharia-compliant investments, it is important to address these issues one by one.

 

Competitive performance

Claims that Sharia-compliant funds underperform when compared to conventional investments are not true. Comparisons between two commonly used indices, the MSCI AC Global Equity and the MSCI AC Asia ex Japan Equity and their Sharia equivalents, show that under certain conditions, the Sharia one can hold its own (see fig. 1).

Crucially, the performance of Sharia indices is largely determined by one factor: the performance of bank stocks. When bank stocks do well, Sharia indices underperform, and vice versa.

Clearly, banks are a major component within conventional indices. Yet, nearly ten years on from the last financial crisis and regulators still concede that some banks are too big to fail; capital inadequacy remains a problem in the wake of undemanding stress tests; ‘Chinese walls’ are weak in the face of continuing conflicts of interest; and transaction costs for bank customers are often excessive.

Therefore, for investors who are apprehensive about the reliability and stability of conventional global banking and finance, Sharia-compliant investment may offer a solid hedge against the next crisis. In fact, had Sharia precepts operated in 2008, they may well have prevented the last one.

One of the reasons for this is because Sharia principles prohibit the paying or receiving of fixed interest. Adherence to this concept, referred to as riba, would have reduced the likelihood of speculative and risky behaviour among over-leveraged banks and insolvent borrowers in the run-up to 2008.

In the same way, Islamic restrictions on debt would have prevented the asymmetries of a system where risk-taking rewards certain individuals while requiring taxpayers to cover any losses incurred.

 

 

Sound principles

Another common misperception is that Sharia law dictates where investments can and should be made. In reality, Islam makes no distinction between the spiritual and the secular; Sharia law merely stipulates where investments cannot be made.

For example, in terms of investments, Sharia places particular emphasis on haram, or ‘forbidden’ industries. Haram extends to all products and services considered addictive, including alcohol and gambling. Accordingly, all income generated from the manufacturing and marketing of pork, prostitution or pornography, among other industries, is also forbidden.

Rather than simple moral prohibitions, the frame of reference of Islamic finance governs personal conduct including individual responsibility to society and the notion of serving the common good.

This social awareness is exemplified in the concept of gharar, which seeks to eliminate ambiguity and deceit in Sharia contracts, including fraudulent acts or other undesirable consequences. From a financial perspective, this means that investment cash flows must be tied to real assets.

The principle of gharar is similar to contemporary ideas behind socially responsible investment (SRI). Under the premise of SRI, investments are based not only on financial return but also on their contribution to the social good.

In recent years, SRI has become embedded in the investing of public institutions in the West, whether by means of SRI-specific, ESG (environmental, social, and governance) mandates, or otherwise.

However, the affinity between Sharia-compliant investment and SRI has not yet been noticed by mainstream investors. Nevertheless, their converging investment concerns and approaches could be incorporated more widely into awareness raising of the potential of Sharia-compliant investments.

 

Due diligence comes first

The final misconception relating to Sharia-compliant investments, in which fund managers are said to lack the required expertise, is being addressed by Aberdeen Islamic Asset Management Sdn Bhd (AIAMSB).

AIAMSB was awarded its Islamic fund management licence in Malaysia in 2009 and is a wholly owned subsidiary of Aberdeen Asset Management Sdn Bhd (AAMSB), which itself is part of a global investment management group. AIAMSB manages funds on behalf of both retail and institutional clients.

Both companies have a common investment approach, grounded in careful due diligence that involves visiting prospects and talking to their senior management before any investment is made. The purpose of this is to forge a deep understanding of the strategy and operations of these entities.

There is a particularly strong emphasis on good governance, accounting and organisational transparency, in addition to ensuring investee boards respect the rights of their minority shareholders.

The objective of AIAMSB is to invest over the long term. To that end, it first looks at downside risks, such as what could go wrong, with the aim of buying only those companies that have strong balance sheets and cash flow.

Moreover, a group of external Sharia scholars is responsible for screening all AIAMSB investments. In fact, because of Aberdeen’s fundamental and comprehensive approach, few adjustments are necessary to make conventional model portfolios Sharia-compliant.

 

Education matters

Clearly, there are fewer investment options available for Sharia-compliant funds than there are for conventional funds. This results in certain sectors being under-represented, or indeed, as is the case with regard to banking, absent altogether.

However, AIAMSB believes that the purchase of multiple stocks alone does not make a portfolio diversified. Rather, it contends that risk can be mitigated by running a concentrated portfolio and having extensive knowledge of every single holding.

Promoting its expertise requires AIAMSB to focus on educating investors about the attractions of Sharia-compliant investments. However, financial literacy across Asia remains weak and the situation is made more challenging by the incentive structure which governs how funds are bought and sold.

Malaysia serves as a benchmark for a way forward in this regard. In recent years, the Malaysian government has taken steps to increase the amount that the Employees Provident Fund (EPF), as the State agency responsible primarily for the administration of private sector workers’ pensions, can invest in Sharia-compliant investments.

Furthermore, the EPF announced that it will offer all members the option of a purely Sharia-compliant pension from 2017. This is set to increase its investments in Sharia-compliant stock, thereby providing a significant boost to the industry as a whole.

Indonesia has also made efforts to improve take-up of Sharia-compliant products. In 2015, the country’s financial services authority relaxed its rules to allow domestic-approved Sharia mutual funds to invest at least 51 per cent, and up to 100 per cent, of underlying assets overseas; conversely, conventional funds remain bound by a 15 per cent cap. This is significant because as long as this discrepancy between conventional and Islamic segments exists, Sharia-compliant funds will offer advantages in terms of diversification.

Sharia-compliant funds, far from representing a restricted choice in terms of performance, diversity and expertise, offer investors a sound and potentially profitable alternative.

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GERALD AMBROSE
Chief Executive Officer
client.services.my@aberdeen-asset.com
ABERDEEN ISLAMIC ASSET MANAGEMENT
SDN BHD
Suite 26.3, Level 26, Menara IMC
Letter Box 66
8 Jalan Sultan Ismail
50250 Kuala Lumpur
Malaysia
+60 3 2053-3800
www.aberdeen-asset.com.my

 

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