Wealth and investments: Islamic finance
Sharia-compliant investing outperforms peers
Did you know that while nearly 25% of the world is Muslim, not even 1% of global financial assets are Sharia-compliant? Not only that, while many funds deteriorated following international lockdowns, many shariah funds outperformed as they lacked exposure to industries that were severely affected by the pandemic.
Untouched potential amongst Islamic investors notwithstanding, non-Muslim investors are also turning their eyes towards halal investments as demand for socially responsible investing rises globally. These signs point towards massive, unrealized growth potential for Shariah-compliant investment funds.
What are Sharia-compliant investments?
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Riba = Interest
Under Sharia law, money is merely a medium of exchange. Because it has no intrinsic value, it cannot be ethically used to obtain more money. Interest is therefore prohibited in all transactions, as it benefits one party at the expense of another. -
Gharar = Unreasonable uncertainty
Transactions that have uncertainty are also prohibited as speculative transactions that lack information could lead to undesirable outcomes. Futures contracts are a good example, whereby the assets transacted might not even exist when the delivery date rolls by. -
Halal = Permissible
Halal transactions are permitted transactions. Conversely, Haram (impermissible) transactions involve activities that are strictly prohibited under Islam. Examples include trade of alcoholic beverages, pork meat, and gambling. -
Mudarabah = Profit and loss sharing principle
All investment stakeholders must shoulder a proportionate amount of risk and split rewards accordingly as well. Depositors must be involved in the agreement and all risks and rewards are calculated in proportion to realized profit or loss. -
The asset backing principle
Financial transactions must involve exchange of tangible and identifiable underlying assets. Traded assets must demonstrate clear benefit and value to its owners. Conversely, transactions backed by demonstrably harmful assets are banned.
Exhibit 1: Sharia-compliant portfolio construction (relative to peer group)
| Asset class | Conventional | Sharia compliant | Islamic principle |
|---|---|---|---|
| Cash | Money market instruments | Sharia-compliant contracts | Ban on uncertainty |
| Non-interest-earning deposit accounts | Ban on interest | ||
| Fixed income | Government and corporate debt | Sukuk | Profit and loss sharing principle |
| Asset-backing principle | |||
| Equity (public and private) | All sectors | Constrained universe | Ban on financing certain economic sectors; restrictions on conventional leverage |
| Alternatives | Derivatives | n/a | Ban on uncertainty |
The Mercer advantage
Verification required
Operational considerations
Legal considerations
Sharia investing: What you need to know
Mercer has developed best in class Sharia-compliant portfolios
Appointing a Sharia-compliant investment manager
Sharia-compliant investing brings a unique set of challenges. Interested investors are advised to commit to Sharia compliance and develop clear frameworks to stay on track throughout the investment process. Understanding asset class opportunity sets and their underlying exposures will enable investors to adjust for risk and returns accordingly.
Besides having comprehensive knowledge of opportunity sets, good Sharia-compliant managers should understand both technical and financial aspects of Sharia-compliant criteria. They should ideally have experience integrating Sharia principles into active fund positions and a track record of being endorsed by Sharia advisory boards.
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