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Article contribution to International Investor– April 2016
Shariah-compliant investment is worth it
Every investment is a leap of faith. To earn a return you must take a risk. For committed investors seeking
Shariah-compliant investments that is all the more true: your beliefs really do guide where you put your money.
There remains a vast segment of the investing public who perhaps would like to consider Shariah-compliant
investing but do not think it for them.
Three perceived obstacles commonly exist. The first is that Shariah-compliant investments impose unusual
restrictions on what can be bought. This denial of choice will hinder performance. Or put another way, your
conscience comes at a cost.
The second is that Shariah-compliant investment is really only for the faithful, concerned as it is with investing
in accordance with Shariah law, and thus with no real application for investors looking to build properly
diversified portfolios.
Last – in ascending order of ignorance – fund managers who run Shariah-compliant funds may not have the
skills necessary, seeing as they will have to be versed in Shariah precepts (as well as competent managers of
money to begin with).
Let’s take these points in turn.
In terms of performance, it is not quite true to say that Shariah-compliant funds underperform. If we compare
the performance of two popular indices, the MSCI AC Global Equity and the MSCI AC Asia ex Japan Equity
and their Shariah equivalents, Shariah-compliant funds ones have disappointed lately.
Yet the reason for their lag, as much as their outperformance earlier through the global financial crisis, is
simple: bank stocks. When they do well, Shariah-compliant funds tends to do less well, and vice versa. So
Shariah frames your investment choice clearly: if you must own banks, Shariah-compliant funds is not for you.
Performance
MSCI AC World
MSCI AC Asia Pacific ex Japan
40
80
30
60
20
40
10
0
20
-10
0
-20
-20
-30
-40
-40
Source: Aberdeen Asset Management, Factset, MSCI, 29 February 2016
31 Dec 15
31 Dec 14
31 Dec 13
31 Dec 12
31 Dec 11
31 Dec 10
31 Dec 09
31 Dec 08
31 Dec 07
31 Dec 06
31 Dec 15
31 Dec 14
31 Dec 13
31 Dec 12
31 Dec 11
31 Dec 10
31 Dec 09
31 Dec 08
31 Dec 07
-60
31 Dec 06
-50
If, on the other hand, you want reasons for not owning banks, here are some suggestions: the persistence of ‘too
big to fail’; of capital inadequacy in the wake of undemanding stress tests; of weak ‘Chinese walls’ in the face
of conflicts of interest; of excessive transaction costs.
Which is to say, if you have misgivings about the way global finance is still run, then Shariah-compliant
investing might be your best hedge against the next crisis. Shariah precepts would certainly have prevented the
last one.
Consider: the ban on trying to earn money from money (“riba”) would have put a lid on speculative greed, be
that of over-levered banks or the borrowers who couldn’t afford the loans. Likewise, strictures on debt would
dis-allow the asymmetries of a system where risk-taking rewards individuals yet losses may end up with
taxpayers.
Some people assume that Shariah dictates where your money must go. But it only says where it can’t. There is
no advocacy – and not of businesses run by or connected to Muslim causes. What Shariah law forbids is
straightforward. It has the appeal of the ancients – a general rather than theological wisdom acquired by age.
For example, to those who find gambling troubling, and the attitude towards it of many governments especially
so – ‘We frown on the social costs but we like the revenues’ – the Shariah outlawing of “maisir” is admirably
plain: gambling is unacceptable.
Shariah law is just as robust on other industries that attract ‘sin taxes’ and which directly or indirectly might
encourage people to get up to no good (alcohol, entertainment, arms…). They should not benefit from your
investment.
It would be too narrow to say Shariah is only to do with moral prohibitions. Its frame of reference is larger – it is
more a set of rules governing personal conduct; the individual’s responsibility in relation to society and the
notion of the common good.
We can see this in the idea of “gharar” which governs contracts and seeks to avoid unclear terms. In financial
practice its reach leads to the insistence that cashflows behind an investment must be backed by a proper asset.
Arcane as it sounds this is a sound basis for running a business – and for not ripping other people off.
In fact “gharar” comes close to modern ideas of socially responsible investment (SRI). In SRI there is also a
negative screening of industries that tend to be polluting – morally or physically – and impose a more general
cost to society in terms of public health, the environment, etc.
SRI has become embedded now in the investing of public institutions in the West, whether that be in SRIspecific, ESG (Environmental, Social and Governmental) mandates, or otherwise.
This affinity between Shariah and SRI has not yet been noticed by mainstream investors. Still, their shared
concerns do provide a way of thinking about Shariah that may help it to become better understood and
acceptable to a broad public, non-Muslim and Muslim alike.
From our perspective as fund managers this overlap is helpful. We have been investing in Shariah-compliant
funds (alongside conventional ones) on behalf of both retail institutional clients for the past few years.
Our investment approach for both is grounded in careful due diligence, which involves visiting companies and
talking to management. We avoid companies we don’t understand, which lack transparency, have unclear
business advantages and which disregard our minority shareholder rights.
In wishing to behave as company owners, we tend to look at downside risks first – what could go wrong. It
follows that a strong balance sheet and cashflow is the bedrock for any company we choose.
Our expertise is not that of Shariah scholars. That is the work of outside experts who vet our investments. But
our natural caution and our long-term focus mean we don’t have to change our approach to run Shariahcompliant portfolios.
Of course, Shariah-compliant investment universes are smaller than unconstrained ones. Some sectors will be
under-represented or not represented at all. But our idea of a balanced portfolio has never been to buy lots of
stocks, thinking this will help diversification. There is much less risk, to our mind, in keeping portfolios
concentrated in stocks we know very well.
If we are comfortable running Shariah-compliant mandates, can we persuade more investors of their merits?
In Southeast Asia, the Malaysian government has provided a strong lead. It has committed to raising the amount
in the Employees’ Provident Fund that is allocated to Shariah-compliant investments. If capital is shifted this
way then non-compliant listed companies may start to notice.
How fast Shariah-compliant investing develops a wider following may also depend on education. Financial
literacy in Malaysia and much of Asia remains weak and is not helped by the incentive structure which governs
how funds are bought and sold.
Still, Indonesia is looking to improve the take-up of Shariah-compliant products. It has just allowed approved
mutual funds to invest at least 51% (up to 100%) of underlying assets overseas. This is a considerable
concession given conventional fund are bound by a 15% overseas cap. So long as this discrepancy exists,
Shariah-compliant funds will have an advantage as a diversifier.
In sum, Shariah-compliant funds more than deserve their place at the investment table. Far from being for the
committed alone, with a little more understanding they should also appeal to anyone who has scruples – and,
importantly, wants them to pay.
Gerald Ambrose
Chief Executive Officer
Aberdeen Islamic Asset Management Sdn Bhd
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