The alignment of Shariah and sustainable investing
Sustainability has risen up the agenda for investors. 57% of respondents to the Schroders 2019 Global Investor Study, a survey of more than 25,000 investors across 32 countries, said they would always consider sustainability factors (such as climate risk, diversity, corporate governance, etc.) when investing. An even greater number, 63%, believe that climate change is having or will have an impact on their investments. The amount of money invested in sustainable funds has soared. As of June 2019, there was over $133 billion invested in this way, quadruple the amount from 2011.
This ground-breaking new research paper (which can be found at the foot of the page), co-authored by Schroders and Maybank Islamic, makes the case that there is a high degree of overlap between the principles underlying sustainable investing and Shariah investing – investing according to the rules set out in the Quran and Sunnah which are the basis for the Muslim religion. This alignment has not yet received the attention it deserves and Muslims have been underserved by the asset management industry.
Shariah investing is premised on promoting the welfare of humankind and preventing harm by preserving religion, life, intellect, the interests of future generation, and wealth. The Islamic view holds that all natural and depletable resources are to be managed in trust in order to ensure the rights of this and future generations are preserved. It explicitly widens the focus beyond financial returns to include the overall well-being and welfare of individuals and society at large, as well as environmental preservation. The parallels with sustainable investing are clear.
Shariah investment products typically exclude companies engaged in activities which are not Shariah-compliant. This includes alcohol, gambling, adult entertainment and defence/weapons, sectors which are also avoided in many socially responsible funds. Other exclusions are more specific to Shariah funds, such as the avoidance of pork.
The prohibition of paying and receiving interest, or riba, under Shariah law also means that companies which exceed prescribed debt or cash limits are not permitted. However, this does not conflict with a sustainability objective. High levels of debt are likely to make a business vulnerable to adverse external developments. By reducing downside risks during times of stress, resilience and sustainability of returns could be improved. In this sense, leverage restrictions could be considered an additional source of prudence. Low leverage is also typically one of the main indicators used to assess the “quality” of a company in a factor exposure sense. A company sitting on a high cash balance could also be an indication of poor corporate governance. As well as being potentially inefficient – it may be better to return excess cash to shareholders – it increases the risk of cash being squandered on ill-advised acquisitions.
Of course, the two areas are not perfectly aligned. In particular, Shariah rules do not permit investment in most of the conventional finance sector.
Our research shows that, as a consequence of these exclusions, the Dow Jones Islamic Market World Index (DJ Islamic World), one of the most prominent Shariah-compliant equity benchmarks,
scores much better than the broad market on a number of sustainability criteria. One measure of this is an aggregation of the unrecognised costs and benefits that a company imposes on society. Costs include CO2 emissions and the costs to governments of managing problems associated with alcohol, gambling and tobacco. Benefits include the social value of employment (compensation levels, employee training etc). We calculate this using Schroders’ proprietary SustainEx model and scale the aggregate figure to a company’s revenues – shown in the chart below as social value/sales. This gives the figure an order of magnitude and allows comparability between companies. Whereas an investment in the MSCI All Country World index has unrecognised costs equal to 2.2% of the market’s revenues (which is equivalent to a 25% reduction in profits if they were to be fully recognised), the DJ Islamic World has an unrecognised positive social impact equal to 4.1% of revenues.
However, while there is a high degree of overlap, the Shariah investment universe has remained small – assets under management are only $3 billion – and slow growing, even as interest in sustainable investing has soared. One explanation for this is that, although Shariah principles place a high value on environmental considerations, the vast majority of existing Shariah investment products ignore them. For example, the MSCI ACWI Islamic index, another common Shariah benchmark, is heavily overweight the energy sector (17% allocation compared to 6% in the MSCI ACWI, as at 30 June 2019). The DJ Islamic World is underweight this sector but this is fortuitous rather than by design, so may not always be the case (our full research paper goes into detail on the differences between these benchmarks, including the reasons why). Muslim investors are currently faced with a choice between two competing options:
- Invest in a Shariah-compliant fund that pays no formal heed to environmental considerations.
- Invest in a traditional sustainable fund, which is not Shariah compliant.
Neither is satisfactory. Our research is a call to action for the asset management industry. The Shariah investment industry has languished but, if it bridges this divide, it has the potential to give the Muslim community much better outcomes.
Dato' Mohamed Rafique Merican, Chief Executive Officer (CEO), Maybank Islamic Berhad:
“There are around 1.8 billion Muslims globally, representing approximately a quarter of world population. But despite these numbers, Muslims have been underserved by the asset management industry, with limited innovation in product offerings and low growth in assets. As of June 2019, only $3 billion was invested globally in Shariah global equity funds.
As the report has shown, Muslims do not have to compromise between their religious beliefs and their desire to invest in a sustainable manner, especially given that the underlying principles are so closely aligned. We believe that by bridging this divide, the global Shariah investment industry can grow and better serve the Muslim community.
This thought paper is also part of our Centre of Excellence (COE) initiative, where we aim to be the reference point on Shariah matters and best practices for industry players, regulatory and academic fraternities.”
Assoc. Prof. Dr. Aznan Hasan, Chairman of the Shariah Committee, Maybank Islamic Berhad:
“Although it has previously received less attention within the Islamic finance fraternity, sustainable investment is, in fact, an embedded principle in Islamic finance. Islam emphasises extensively the sustainable development and protection of the life, which is one of the general purposes of the Shariah (maqasid Shariah). Of course, this notion of sustainable investment should be understood and interpreted within the principles of Shariah. Hence, the alignment of Shariah and sustainable investment as advocated by this report is very timely and highly commendable. I congratulate the team for preparing this important research.”
Jessica Ground, Global Head of Stewardship, Schroders:
“Historically investors who were interested in investing according to their values were limited to just focusing on what a company produced. Shariah-compliant investments are a prime example. But we all know that how a company conducts its business is equally important, especially when evaluating the impact on the wider world. As sustainable analysis and data grows, Muslim investors now have the opportunity to move beyond mere compliance, to holistically express their values and assess the impacts of their investments. A shift towards a more explicit focus on sustainability is both in keeping with the teachings of Islam and aligned with what investors worldwide are increasingly demanding.”
You can download the full report by clicking the links below:
- The alignment of Shariah and sustainable investing - Full paper (14 pages)
- The alignment of Shariah and sustainable investing - Summary paper (5 pages)
- The recent challenges of active equity investing – and why this might change
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