Shariah-compliant investments are governed by the requirements of Shariah law and the principles of Islam. They are often considered to be a specialist branch of ethical investing.
The rules and requirements of Shariah principles mean that companies involved in certain activities will be filtered out of a Shariah-compliant fund, notably:
- Conventional finance (non-Islamic banking, finance and insurance, etc.)
- Pork-related products and non-halal food production, packaging and processing or connected activity
- Adult entertainment
- Weapons and defence
In addition, there are requirements surrounding the use of debt and interest-bearing assets. Islamic law prohibits the collection and payment of interest by lenders and investors. To earn money without charging interest, Islamic banks agree to participate in a certain amount of profit or loss the business generates.
There are also some generally accepted accounting restrictions in Shariah investing. Companies must maintain a debt to equity ratio less than 33%, which rules out businesses with high levels of borrowing and means a focus on more stable businesses. In addition, companies must generally have accounts receivable and cash of less than 50% of total assets.
There are a number of global and area-specific indices designed to help direct investors to companies that comply with Shariah investment principles such as those compiled by FTSE Russell and MSCI. They can provide a useful reference point for examples of companies that are considered to meet the principles, and certain funds are based on their composition. These are generally run on a ‘passive’ basis to replicate the performance of the index.
The investment screening process is comparable to that of ‘negatively screened’ ethical funds using ESG (environmental, social and governance) criteria. However, a Shariah-compliant fund will also have a Shariah board made up of Islamic scholars who decide or check which companies meet the rules. Different funds will have slightly different policies according to the beliefs and interpretations of their advisory board, so investors are advised to consult the fund’s prospectus to ensure it meets their own principles before investing.
As is the case with ethical investments, the extra layer of rules restricts fund managers from certain areas which could enhance or detract from returns over time. For instance, financials such as banks are mostly excluded but are often a large part of broader stock market indices. The outperformance or underperformance of this area would have implications for fund returns. Due to the outcomes of the screening process, there is often a sectoral bias toward healthcare and information technology.
Many funds operating in the area have high minimum investment sizes or are otherwise inaccessible to UK private investors. However, there are some that are easily accessible and have reasonably competitive charges, for instance:
While the options for Shariah-compliant investments remain somewhat limited at present, the movement towards broader responsible investing – whereby increasing numbers of people wish to see their values reflected in their investment portfolio – could see this niche area expand and evolve too.
There are some clear parallels between Shariah investing and principles of sustainability that encompass strong corporate governance, environmental stewardship and societal good. In some cases, broader ethical or responsible funds might also meet an investor’s Shariah investing needs and principles due to the high degree of overlap, though care should be taken when selecting this type of fund. It is important to read fund literature carefully to check values are aligned with your own. Important resources in this regard are the fund’s Key Information Document, Prospectus and (if applicable) the Impact Report.
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