Is Shariah and Sustainable Investing one and the same?
Published on 9 March 2020
Published on 9 March 2020
Shariah investing has traditionally targeted Muslims. There are approximately 1.8 billion Muslims globally, representing around a quarter of population on Earth; this represents a sizeable demand for investing in a Shariah compliant manner. However, despite the number, Muslims have been underserved by asset management industry with limited product innovation and low asset growth.
As of June 2019, only USD3 billion was invested globally in Shariah global equity funds. Furthermore, most funds have struggled to achieve scale in 2017 and 69% of funds had assets under management of less than USD25 million1.
This can be contrasted with the rapid growth of assets invested along sustainability lines. There is now over USD133 billion invested in this sector’s funds. This is quadruple the amount invested in 2011.
Figure 1: The Shariah universe is small and growing slowly; the popularity of sustainable investing has soared
Source: Broadridge | July 2019
Shariah and sustainable investing
What common principle unites Shariah investing and sustainable investing?
Incorporation of sustainability considerations is both complementary in philosophy to Shariah investing and has the potential to improve investment outcomes. There are many variants of sustainable investing but the common underlying principle that Shariah and sustainable investing share is to incorporate how a company interacts with the society and the environment in the investment decision making process.
The objective of Shariah law (Maqasid-al-Shariah) is to promote the welfare of humankind and prevent harm2 which holds the view of all natural and depletable resources are blessings and they are to be managed in trust. This is in order to ensure the rights of current and future generations are preserved. Therefore, Shariah investing 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.
However, Shariah investing excludes companies involved in sectors which do not comply with Shariah principles. Shariah investing excludes companies that do not comply with Shariah principles, such as earning revenues from prohibited activities (e.g. alcohol, gambling, adult entertainment and non-Shariah compliance finance). The prohibition of interest, or Riba, under Shariah law also means that companies which exceed prescribed limits on the portfolio of debt or cash are not permitted. Based on these circumstances, environmental impact is not normally a consideration.
What about areas of difference between Shariah and sustainable investing?
The two main areas of difference between Shariah and sustainable approaches to investing concern the prohibition of (receiving or paying) interest and the exclusion of the traditional finance sector. The first of these can be considered consistent with conventional (non-Shariah) views on sustainability, although the latter has no equivalent (Table 1).
Table 1: Some areas of difference can be bridged relatively easily
|Shariah investing principle||Relationship with sustainable investing|
|Prohibition of interest||A bias away from highly indebted companies is consistent with sustainable investing; high levels of debt are likely to make a business vulnerable to adverse external developments. Low leverage is also typically one of the main indicators used to assess the “quality” of a company in a factor exposure sense. Shariah portfolios are biased towards the “quality” factor.|
|Exclusion of traditional finance sector||No equivalent restriction. Traditional sustainable investment products are not Shariah-compliant. Where Shariah compliance is essential, Shariah principles must take precedence. Shariah-specific products are required.|
Source: Schroders | November 2019
Current offerings force a compromise
Investors - Muslims or otherwise - are currently faced with a choice between two competing options:
Neither is satisfactory. Furthermore, 66% of Asian respondents to the Schroders 2019 Global Investor Study said they would always consider sustainability factors when selecting an investment product, higher than the 57% globally who agreed with this statement. In other words, there is strong demand for investment products which take account of sustainability factors, however, it is seen that investors are compromising their Shariah beliefs in order to source them.
A call to action
Since sustainable investing is growing in popularity, many investors putting an increased emphasis on this especially on how they allocate their investments and how their portfolio can be impacted. There is an opportunity for the Shariah investment industry to capitalise on this by converging the sustainability consideration. Incorporation of sustainability considerations is both complementary in philosophy to Shariah investing and has the potential to improve investment outcomes.
This is a summary version of a longer paper on the alignment of Shariah and sustainable investing. For the full paper, click here.
1 Source: Islamic Financial Services Industry Stability Report, 2018
2 Source: Introduction to Islamic Economics, Askari et. al, 2015