Responsible investment and Shari’a investing

Responsible investment and Shari’a investing

Over the past two years, there has been a significant amount of financial commentary produced regarding the rise to prominence of responsible investing, but in comparison, very little has been written about Shari’a investing. The principles of Shari’a govern all aspects of life and focus on strong ethical views that are based upon efficient use of resources, fairness and giving more than is due. To provide some additional context, pollution reduction and the provision of clean energy and resources both follow the Shari’a principle of ‘stewardship of the environment’. The reduction of poverty and enhancement of equality is referenced in both the Sunnah and the Qur’an. Therefore, it is clear to see that there is a significant degree of commonality between responsible investment and Shari’a‑compliant investing.

However, irrespective of the shared commonality, there are noticeable differences in the construction of an investment portfolio integrating environmental, social and governance (ESG) factors and a Shari’a‑compliant one. Within responsible investment, an increasing amount of time and effort is being spent on engagement with companies regarding their internal approach to managing ESG factors. This means that companies can be challenged on a multitude of issues, ranging from carbon emissions to gender diversity, with one focus in mind: to drive change. In contrast, Shari’a‑compliant investing requires a more stringent approach, as there are a number of sectors where investment is prohibited. These include:

  • conventional financial institutions;
  • alcoholic beverages;
  • gambling/gaming;
  • pork production;
  • non‑halal food products;
  • adult entertainment;
  • arms, defence and military equipment; and
  • tobacco.

In addition to the prohibition of investment into certain sectors, there are a number of financial metrics that are used in order to eliminate companies that are heavily indebted and/or receive interest or income from non‑compliant activities. The relevant metrics are:

  • Debt must be less than 33.3 per cent of total assets.
  • Cash and interest‑bearing items must be less than 33.3 per cent of total assets.
  • Accounts receivable and cash must be less than 50 per cent of total assets.
  • Total interest and non‑compliant activities income should not exceed 5 per cent of total revenue.

In order to ensure that companies are Shari’a‑compliant, they will need to pass both the sector‑specific and financial screens.

As responsible investing has soared in popularity over the past two years, there are now many investment solutions available to retail clients, including mutual funds and exchange‑traded funds that are weighted to consider ESG factors. The same cannot be said for Shari’a investment solutions, as they remain mostly fund‑based with limited transparency and have traditionally associated ongoing charges of circa 1.5–2.5 per cent.