What are Shariah investments?
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What are Shariah investments?

Updated
28
Jun 2024
published
14
Jun 2024
What are Shariah investments?
  • Shariah investment aligns with Islamic values by avoiding haram activities and high-debt companies.
  • It attracts both Muslim and non-Muslim investors who seek ethical investment options.
  • Shariah-compliant indices often perform comparably or better than conventional indices, with lower volatility.
  • Sukuk are Shariah-compliant alternatives to bonds, offering steady returns without involving interest.
  • Shariah investment is growing in popularity, with efforts to increase fund options in regions like Singapore.

Imagine a way of investing that not only aims to grow your wealth but also aligns with your ethical values and faith. That is the essence of Shariah investment. 

Rooted in Islamic principles, Shariah investment follows a few sets of principles, such as avoiding companies involved in activities considered haram (forbidden), such as gambling, selling alcohol, or dealing in interest-bearing securities (riba).

What is Shariah investment?

Shariah investment is not merely for those of the Islamic faith, as it is gaining traction among a broader investor base, including non-Muslim investors, who see it as a form of ethical investing through excluding companies engaged in harmful activities and reflecting their values with their money and where they invest.

What about investment performance? One of the tenets of Shariah investment is to avoid companies with high levels of debt, which is essentially quality investing that can help to lower volatility and result in more controlled downside losses during market turmoil. This focus on financial health and ethical practices has made Shariah funds a compelling choice for risk-averse investors.

Driven by such appeal, the popularity of Shariah investment is on the rise. According to Morningstar, assets in Islamic funds have doubled to SGD 59.3 billion at the end of February 2023 from SGD $29.8 billion in 2013. This growth highlights the increasing appeal and acceptance of Shariah-compliant investments in the global financial landscape.

How is Shariah investment done?

While exclusion is a way to achieve Shariah investment principles, the underlying principles that ensure investments align with Islamic values are:

  1. Prohibition of Haram activities: Shariah-compliant investments must avoid businesses involved in forbidden activities like gambling, alcohol, pork, and adult entertainment.

  2. Limiting debt: Companies with high debt levels are generally excluded, as the concept of debt is generally discouraged in Islam.

  3. Prohibition of interest (Riba): Investments that earn interest, such as traditional fixed income securities, are off-limits, a fundamental principle to Shariah investment.

Equity investing

Despite the Shariah principles that prohibit investing in a company with any involvement in haram activities, finding a company that is 100% halal can be challenging, especially in today's complex business world. Many companies have multiple business arms and take on debt to grow efficiently. 

To address this, Shariah-compliant funds often adopt a more practical and pragmatic approach by setting thresholds for haram activities and debt levels. For instance, a common practice is to allow investment in companies that:

  • Generate no more than 5% of their revenue from haram sources.
  • Maintain debt-to-equity levels below 33%.

These thresholds, while not perfect, provide a practical way to invest in a manner that is reasonably Shariah-compliant and are often approved by Islamic scholars.

Aside from weighing in on these thresholds, Islamic scholars also often provide additional checks and balances on the final portfolios constructed by fund managers. 

Even if a company meets the threshold criteria, there may be other nuanced factors that require more qualitative inputs and debates to determine its Shariah-compliance. To address this, Shariah fund managers frequently engage independent Islamic scholars to conduct thorough reviews, ensuring that the final portfolios adhere to Shariah principles.

Meanwhile, some fund managers have also developed innovative approaches to enhance the meaning of Shariah investment. For example, HSBC Asset Management employs an “income purification” method. That is, if a company in their portfolio generates a small percentage of revenue from haram activities, the corresponding portion of any dividends received is donated to charities supporting Muslim communities. 

Sukuk investing

While traditional “fixed income” instruments that generate interest (riba) are prohibited, Shariah investors can tap into a similar security instead – sukuk. Sukuk has a rich history and is one of the oldest forms of financial instruments, with the word "sakk" (plural for sukuk) even giving rise to the English word "cheque".

In traditional bonds, the lender earns interest without being involved in the businesses or projects funded by the loan. In the perspective of Shariah investment, without being involved or contributing to the underlying economic activity, it is unethical to earn “guaranteed” fixed return, which, in traditional bonds, is represented by in the form of interest or riba. This separation of profit from risk is prohibited in Shariah investment. 

How do sukuk involve both risk and rewards?  Imagine a borrower needing funds for a business project. Instead of just borrowing money, they will firstly set up a separate entity dedicated to that project. This entity then issues sukuk, which represent ownership stakes in the entity. Investors buy these sukuk, providing the necessary funds and, in return, they share in the project's risks and rewards.

Sukuks are usually issued after a rigorous review by Shariah boards or scholars who make sure that the underlying business and its activities are Shariah compliant, as well as the structure of the sukuk. Once everything checks out, the scholars issue a fatwa (Islamic legal opinion) certifying the sukuk’s compliance. This endorsement is crucial information for sukuk fund managers.

Of course, investing involves more than just checking Shariah compliance – this is where fund managers' expertise comes in. Managers like Azimut ensure that the sukuk they invest in are not only Shariah-compliant but also issued by high-quality parent companies funding attractive business opportunities. This dual focus helps grow investors' wealth while adhering to Islamic principles – the investing expertise of fund managers remains vital in making successful Shariah investments.

Do Shariah investments sacrifice returns?

A common concern for investors considering Shariah-compliant funds is whether the additional layer of Shariah compliance might lead to less favourable returns compared to non-Shariah investments. This worry often stems from the belief that adhering to Shariah laws reduces the pool of eligible companies, potentially limiting investment opportunities.

The short answer is; not necessarily.

To see why, let’s dive into the historical performance of some equity indices: MSCI ACWI vs. MSCI ACWI Islamic, Dow Jones Global vs. Dow Jones Islamic World, and S&P 500 vs. S&P 500 Shariah. These pairs compare major equity market indices with their respective Shariah-compliant counterparts.

The Islamic or Shariah investment has not necessarily lagged behind the conventional market indices. The MSCI ACWI Islamic has shown returns similar to MSCI ACWI, while DJ Islamic World and S&P 500 Shariah have outperformed their broad market counterparts on a cumulative basis.

On an index level, it's clear that the Islamic or Shariah investment has not necessarily lagged behind the conventional market indices. In fact, the MSCI ACWI Islamic has shown returns similar to MSCI ACWI, while DJ Islamic World and S&P 500 Shariah have actually outperformed their vanilla counterparts on a cumulative return basis.

So, what has caused this outperformance? Islamic market indices tend to place more weight on technology stocks and exclude companies in sectors like financial services, which are considered haram due to their interest-collecting business model. 

Coincidentally, technology has been the best-performing sector in recent years, giving Shariah market indices a nice boost. Of course, this also means that Shariah indices might be adversely impacted when the market rotates away from tech and growth sectors, as seen from the heavier drawdowns of DJ Islamic World and S&P 500 Shariah in 2022. But over the long term, the indices tend to even out, suggesting that Shariah rules do not necessarily put a dent in your returns.

Looking at the historical performance of Bloomberg Global Aggregate (global fixed income index) and Dow Jones Sukuk index, we can observe that sukuk have generally shown a more steady and less volatile return pattern compared to global bonds. 

Over to sukuk, looking at the historical performance of Bloomberg Global Aggregate (global fixed income index) and Dow Jones Sukuk index, we can observe that sukuk have generally shown a more steady and less volatile return pattern compared to global bonds. 

This means sukuk can be a great option not just for Muslim investors looking for a fixed income alternative, but also for non-Muslim investors seeking a potential diversifier for their fixed income portfolios.

Of course, Shariah-filtered equities and sukuk each have their own characteristics and can be affected by prevailing market conditions just like any other investments. This is especially true when also considering the different Shariah fund managers who have varying investment styles. As illustrated, Shariah investments don't necessarily mean sacrificing returns. With the right approach, it can be a rewarding way to grow your wealth while staying true to your values. The observation is consistent across equity and sukuk. 

How to invest in Shariah-compliant funds in Singapore

While Shariah investment is gaining popularity worldwide, Singapore lags behind in the availability of Shariah-compliant fund options for retail investors, particularly those offered in Singaporean dollars. 

More than half of the world’s assets in Shariah funds are domiciled in Malaysia and Saudi Arabia, with less than 1% in Singapore, a study in August 2023 finds. Offshore funds typically distributed in Singapore (those domiciled in Luxembourg, Cayman Islands, Ireland, Jersey and more) represent roughly 11% of global assets in total, as well.

Distribution of global Islamic fund assets in 2022, by domicile

Source: Statista

For any investor in Singapore who has tried to start investing in Shariah-compliant funds, this statistic hits closer to home – our market faces a shortage of investment options and more often than not, are offered at hefty fees.

Recognising this challenge, Endowus is actively collaborating with global leading fund managers to bring more Shariah-compliant fund options to Singaporean retail investors. Their goal is to provide these options at the lowest possible costs, through our industry-first trailer fee rebates.

Here is a list of Shariah-compliant funds currently available on Endowus, with more in the pipeline:

Fund Asset class Sector ISIN (Funding source) YTD Return (Jan to May 2024) 1Y Return 3Y annualised return Net TER (inclusive of Endowus Fee)
Franklin Templeton Shariah Equity Equities Diversified (Active) LU0889566641 (Cash, SRS)
LU1267930813 (CPF)
8.40% 16.56% 4.76% 1.15% (Cash, SRS)
1.05% (CPF)
Franklin Templeton Shariah Technology Equity Equities Technology LU2458330169 (Cash, SRS) 14.17% 31.81% 10.1% 1.12%
Franklin Global Sukuk Fixed income Diversified (Active) LU0923116197 (Cash, SRS) 1.21% 1.48% -0.64% 1.00%
HSBC Global Islamic Equity Index Equities Diversified (Passive) LU2602419157 (Cash) 16.20% 28.02% 10.3% 0.625%

*Annualised returns are calculated based on the returns of the target share class, and the oldest share class of the fund where the target share class is younger than three years. Three-year returns are based on the period from June 2021 to May 2024 unless otherwise stated. Returns are translated into SGD (except for non-SGD funds) and are net of fund-level fees.
***Endowus does not charge a preliminary sales charge or any other additional fees, other than the all-in Endowus Fee.

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