Shariah Investing: the growth of the Islamic Finance gives private clients more options than ever before

Wed 30 Jun 2021

This article is the first in a series about Islamic investing

Most investment advisers have encountered investors looking for Shariah compliant portfolios at some point. My own experience has previously been one of frustration as the universe of investable funds did not offer enough options to be able to construct portfolios which satisfied clients’ risk tolerance. Now that has changed because the significant growth of Shariah compliant financial instruments issued over the last few years has created investment opportunities that were previously absent. This enables us to create portfolios which are both Shariah compliant and correspond to clients’ tolerance for risk.

In order to be Shariah compliant investments must satisfy three broad criteria: companies must not engage in certain prohibited business activities, companies must be managed in a financially conservative manner and the financial instrument that investors purchase must not generate interest but instead should be linked to the performance of an underlying asset. This last point was particularly restrictive because it effectively ruled out bond investments and meant that creating a balanced portfolio was not possible for all except those investors with high risk tolerances that did not require the stability provided by fixed income investments.

Over recent years the growth in Shariah investments has been remarkable. According to the latest Refinitiv Islamic Finance Development Report, the total value of Islamic Finance assets rose from $1.7trn in 2012 to $2.9trn in 2019 and is projected to grow to $3.7trn by 2024. This growth of investable assets has sparked a large increase in the number of funds and ETFs which invest in Islamic instruments and created the choice of investments which was not previously available, perhaps most significantly in the Sukuk market.

Sukuks are an instrument that many investors may not be familiar with, but they are the solution to the to the problem of the prohibition of interest generating securities under Shariah principles. They are a Shariah compliant bond alternative that is linked to an underlying asset rather than being a debt instrument, yet they give the same risk-reward profile of bonds. The Sukuk market has more than doubled from 2012 to 2019, fuelling growth in the number of funds which invest in Sukuks and making Sukuks more accessible to investors. For portfolio construction this is crucial because it enables diversification at an asset class level, where traditional portfolios would have an equity/bond split. Adjusting the proportion of equities and bonds in a portfolio is the principal means of controlling risk and allows portfolios to meet the risk characteristics demanded by investors.

At Mazars we are encouraged by the growth of Islamic Finance and Shariah compliant investments as it enables us to apply the same asset allocation and fund selection processes to these as we use when managing our other discretionary mandates, thus expanding the ways that we are able to serve our clients.

-James Hunter-Jones, CFA