Shariah Compliant Investments

  • SumoMe

Social responsibility and ethical practices are corporate mantras and now catch phrases for investors. Investors are now more aware about corporate governance issues and the social responsibilities of businesses. Interestingly this awareness is slowly enveloping an investors investment decisions.  It comes as no surprise then that the world has witnessed a growing interest in socially responsible investments and one such practise that is gaining momentum is the Shariah compliant investments (SCI). India too has seen, in recent years, a number of investment trusts and mutual funds that are Shariah compliant. A report by PWC in 2009 indicated that the SCI’s are growing at nearly 15-20% a year and the equity fund assets alone are forecasted to jump from $15bn in 2008 to $53bn by 2010.

Shariah (Islamic Law) is defined as a as a body of divine laws, rules, code of conduct and teachings which are intended to benefit the individual and society. Shariah-compliant funds on the other hand are investment vehicles which are fully compliant with the principles of Shariah law. The underlining objective of Shariah is the happiness and well being of human beings and achieving this with an equitable balance between wealth creation and consumption.

A Shariah-compliant company must therefore meet certain criteria based on qualitative and quantitative parameters. The qualitative parameters are used to ensure that these companies are not engaging in any of the following activities: Financial services based on Riba (usury), Gharar (conventional insurance), and Maisir (gambling), production or trade of non-halal (prohibited) goods, such as alcohol and pork. With many companies having a diversified array of businesses it becomes difficult to find companies who don’t engage in any of these activities. Hence additional criteria are looked into in the case of companies engaging in a mix of activities. First, the public perception of the company is looked into, which ought to be meritorious. Second, the core activity into which the company is engaged must be in public interest, with prohibited elements forming a negligible part of their activity.

The quantitative parameters on the other hand ensure that the non halal (prohibited) activities of the company do not exceed the permissible limit. For example the total debt to total assets ratio should not exceed 33%, the account receivable to total asset ratio should not exceed 45%, and the non-operating interest income to revenue should not exceed 5%. Companies who engage in a considerable amount of non-halal activity can purify their profit by donating a percentage of their income to a charitable organisation, before the distribution of dividends to shareholders.

A question that is frequently asked with regard to SCI’s is whether these funds outperform regular conventional funds? This question has faced a lot of conflict and there is no one clear answer to the same. Studies by Margolis & Walsh as well as an award winning paper by Orlitzky et al suggested that there was a positive relationship between a company’s social and financial performance. Conversely Geczy et. al (2005), was of the opinion that SCI portfolios underperformed by as much as 3.6% per year. A study conducted by Hakim and Rashidian (2002) on the comparison between the performance of the Dow Jones Islamic Market Index (DJIMI), with Wilshire 5000 Index using data for period 10/12/1999 – 9/4/2002 revealed that on a risk-return basis, there is no loss from the screening process used for DJIMI stocks.

With growing concerns relating to the environment world over as well as the pressing need for the corporate sector to engage in socially responsible projects it may not be too long before the Indian stock market also benchmarks companies on some socially responsive criteria in the lines of Shariah compliant investments.  This perhaps would be a third strand for investment analysts who are currently armed with the fundamental and technical analysis to assess the risk–returns of an investment portfolio.

Tushanka

[Image courtesy: http://bnp.org.uk/wp-content/uploads/sharia-law-text.jpg]

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