In recent history, global equity markets have observed considerable volatility, leading some investors to either seek more stable fixed-income investments or pursue alternative investment opportunities. For those who have remained in equities, Islamic Exchange Traded Funds (ETFs) have emerged as a particularly resilient investment choice during these periods of market unrest, consistently outperforming their counterparts invested in 'sin stocks' such as alcohol, gambling, and tobacco.
Data from S&P Global would suggest that the S&P 500 Shariah Index has outperformed the benchmark 500 by 2.3% across the past 5-year period, annually. The essence of Islamic finance lies in its adherence to Islamic beliefs, teachings, and values, which not only prohibits investments in certain sectors (such as gambling, tobacco, and alcohol) but also mandates ethical and socially responsible investing.
Outperformance of Islamic ETFs – An Ethical & Performance Advantage
A recent paper by the University of Sydney, in a study on the returns of faith-based mandates in Islamic ETFs from 2008 to 2021, utilised the MSCI World Islamic ETF to show that Islamic ETFs tend to outperform their benchmark counterparts during market downturns.*
This phenomenon is partly attributed to the inherent risk-averse nature of Islamic finance principles, which avoid highly leveraged businesses. This is determined by applying financial ratio screens which exclude companies with ‘substantial interest exposures’. The authors also note that, ‘this leads to investment in companies that have substantial cash reserves [and therefore] have the flexibility to deploy funds for purposes such as acquisitions, research & development and stock buybacks’. However, it is important to note that, while higher debt exposure is linked to increased financial risk, it also does present an opportunity for outsized returns; the paper notes that there is a possible hinderance of Islamic ETF performance during ‘low-interest rate environments’, due to the exclusion of firms that access ‘cheap debt’.
By investing in sectors that generate positive externalities to society, such as renewable energy or sustainable agriculture and avoiding those that are potentially harmful, the authors claim that these funds offer the dual benefit of comparatively more stable investment returns and ‘social good’. This faith-consideration may be attractive not only to those following Islamic finance principles but potentially other FBAOs globally who are increasingly prioritising ethical considerations in their investment decisions.
Prospects and FCI Considerations
The robust observed performance of Islamic equity ETFs displays a growing potential for faith-based and values-based investment funds in the broader market. For our Faith-consistent investors this represents a promising example of aligning both financial goals with beliefs, teachings, and values. It is important to note that this study has back tested performance which is not necessarily a reliable indicator of future performance. Rather, we can look to gain some key insights from the authors on the historical performance of Islamic investments.
The upcoming FCI Training shall further explore the integration of faith-values with resilient investment strategies. Potentially paving the way for new methods and approaches towards faith-consistent investing that also provide robust performance.
*The returns of faith-based mandates in Islamic ETF Methodologies, Shumi Akhtara, Kevin Chenb, Humayon Darc, and Maria Jahromi. Not peer reviewed. Available via S&P Global Market Intelligence Research Paper Series