Shariah-Compliant Funds Gain in Popularity and Outperform

Muslim and non-Muslim investors alike have enjoyed the unique fixed income and robust equities in these funds where faith and ESG can overlap.

Abdulai Mohamed, CFA 19 April, 2023 | 10:12AM
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 A copy of the Quran

Islamic Shariah-compliant mutual funds and ETFs have become popular investment options for Muslim investors around the world. However, non-Muslim investors can also benefit from Shariah-compliant funds because their values-based approaches overlap with environmental, social, and governance (ESG) factors.

These investment vehicles adhere to Islamic principles and guidelines, making them suitable for investors who want to invest in accordance with their religious beliefs and/or personal values.

What Are Shariah-Compliant Investments?

Shariah-compliant funds invest according to Islamic law. Islamic teachings consider activities like gambling, alcohol, tobacco, and usury harmful or unethical and prohibit Muslims from investing in enterprises engaged in them. Islamic funds have Shariah boards of Islamic scholars that screen potential investments to ensure compliance. Healthcare, technology, and education companies often clear the vetting, while brewers, distillers, gaming companies, and banks that collect and pay interest usually do not.

Shariah Led to Success

Shariah-compliant mutual funds and ETFs have performed well in recent years, with many beating their non-Islamic counterparts. For example, the Dow Jones Islamic World Total Return Index, which measures the performance of Shariah-compliant companies, gained 12.98% annualized over the last 10 years through March 31, 2023, while the broader MSCI All-Country World Index rose 11.63%.

Avoiding indebted companies helped Shariah strategies. Debt-light companies are not only more acceptable to Islamic funds, but they also tend to have stronger balance sheets and less financial risk.

Shariah-Compliant Funds Double in Size Over Last Decade

Globally Shariah-compliant strategies have grown over the past decade. According to Morningstar’s data, Shariah-compliant total assets doubled to CAD $60.4 billion at the end of February 2023, from CAD $30.3 billion in February 2013. The number of Mutual funds and ETFs also more than doubled from 327 to 669 in that period. And some investment vehicles didn’t report their AUM, so these numbers are likely understated.

Most Shariah-compliant funds are in Malaysia, Indonesia, and Saudi Arabia, which account for 73% of the market share, according to Morningstar data. Malaysia alone accounts for nearly 50% of the global market.

More than half of Shariah-compliant mutual funds and ETFs are in equities, followed by allocation and fixed income.

Shariah-compliant fixed income looks different since Islam prohibits interest. Shariah-compliant fixed-income funds typically invest in sukuk, or Islamic certificates that are like conventional bonds. Like bonds, governments, corporations, or other entities issue them to raise capital and often promise to buy them back at par value, but unlike bonds, sukuk gives investors a direct ownership stake in and share in the profits of the underlying assets or projects they finance. The idea is to tie the income stream of sukuk more closely to the profits and distributions of the enterprise rather than the speculative movements of market yields.

Not Just for Muslims

Shariah-compliant strategies offer advantages for both Muslim and non-Muslim investors. For Muslim investors, these funds provide opportunities to invest in ways that align with their religious beliefs. This can provide comfort and peace of mind to investors who wish to avoid investments that may be considered haram (prohibited) under Islamic law. And that could help them stay invested for the long term, even when markets get rough.

For non-Muslim investors, Shariah-compliant funds offer a way to own profitable, debt-light companies that also meet other ESG criteria, such as the exclusion of tobacco, alcohol, or gambling.

Canada Lags Behind on Shariah-Compliant Funds

Canada so far has been sitting out the Shariah-compliant strategy growth trend. Global Growth Assets launched the first halal mutual fund in Canada in March 2009, named the Global Iman Fund. It took until 2019 for Wealthsimple to introduce the first Canadian-domiciled Islamic ETF: Wealthsimple Shariah World Equity ETF.

Since both funds avoid some securities for ESG reasons, they have been marked as ESG Exclusions funds by the Canadian Investment Fund Standards Committee as per their recently released responsible investment identification framework.

The Canadian Shariah-compliant investing market remains untapped. Some Islamic investors may not be investing at all, while others may resort to private wealth advisors.

The Only Canadian-Domiciled Shariah-Compliant Mutual Fund

The Global Iman Fund, managed by Tony Ciero and Cindy Blandford, picks 29 Shariah-compliant stocks from the Dow Jones Islamic Market Index 100 Titans (DJIMI). It has beaten the Morningstar Global Gross Index and Global Equity Morningstar category average by 0.8 and 3.6 percentage points, respectively, over the past 10 years through Feb. 28, 2023. Assets have grown from CAD $3.1 million in February 2010 to CAD $125 million in February 2023.

Shariah-compliant investments provide investors with an opportunity to invest in accordance with their religious beliefs and can appeal to non-Muslim ESG investors. As demand for socially responsible and ethically conscious investing continues to grow, Canadian investment providers should take notice of Shariah-compliant investment vehicles’ potential.

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Securities Mentioned in Article

Security NamePriceChange (%)Morningstar Rating
Wealthsimple Shariah World Equity ETF30.47 CAD0.73Rating

About Author

Abdulai Mohamed, CFA  is a Manager Research Analyst for Morningstar.  

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