THE last two years have shaken traditional western forms of finance to the core. Lax regulation combined with complex trading products proved to be a lethal cocktail and governments across the developed world are now picking up the bill for hefty bailouts.
But should investors be looking at other financial models to invest their cash? Islamic finance, which conforms to the principles of Sharia law, has predominantly been based in the Middle East but there are ways to access it in the UK and one way is through listed products. Exchange-traded fund (ETF) provider iShares offers an Islamic ETF that tracks the MSCI USA Islamic index.
So how does the ETF work? It doesn’t offer exposure to the Middle East or Islamic companies per se; instead it looks at companies that are part of the MSCI US index, and uses a filtering mechanism to include companies whose activities are allowed under Sharia.
The first filter looks at the companies’ business lines. Some business would be excluded because their activities are banned under Sharia law, for example alcohol and pork production, tobacco, financial products and gambling, explains Fahad Mehboob, relationship director at Europe Arab Bank, who is based in London.
The index also excludes companies that derive significant income from interest and have excessive leverage levels. This actually helped the index to outperform during the financial crisis, says Mehboob, because the conventional banks, which make up a significant part of the MSCI index, were sharply sold off.
A BETTER RISK PROFILE
Obviously non-Muslim investors don’t stand to gain anything from a religious point of view by investing in a Sharia-compliant ETF but there are other benefits. Sharia-compliant investing is a bit like ethical investing. But financial ratio screening actually makes sense for non-Muslim investors who don’t want excessive risk in their portfolio: “The general principle is that excessive leverage is not true to the essence of Islamic finance. This makes it inherently less risky,” Mehboob says.
Western indices that are Sharia compliant could prove to be popular with Middle Eastern investors that are awash with petro-dollars, says Mehboob. Middle Eastern investors have traditionally had huge exposures to their home market, especially real estate, and are starting to diversify, he adds.
The iShares MSCI USA Islamic ETF, which came into existence in 2007, has outperformed the actual MSCI USA Islamic Index. In the last three months it has posted returns of 6.24 per cent relative to 6.01 per cent for the index. it also pays a bi-annual dividend of 1.3 per cent.
If you want to help diversify your portfolio then sharia-compliant investing could be for you.