You can invest in the market without contravening your religious beliefs.
Islamic finance has enjoyed a surge recently, on the back of soaring oil revenues in the Middle East, and a wider appreciation of the potential of this underserved market. From modest beginning in the 1970s, total assets under management according to Islamic principles has grown to an estimated $1 trillion worldwide.
There's also been push from government. Financial exclusion has been recognised as particularly undesirable in the current climate, and a few years ago Gordon Brown urged London to become a focus for Islamic financial products. On Thursday came The Financial Services and Markets Act 2000 Order 2010, which reduce legal costs for sukuk -- Islamic bonds -- and make it easier to issue them.
The main hurdle has been the issuing of debt. Prohibited under the Shari'ah rules that govern Muslim life, it has historically left many Muslim families unable to buy a home. Shari'ah compliant financial mortgages work by the bank buying the home, marking it up in price, and then selling it back in instalments -- hair-splitting to non-Muslims perhaps, but a welcome opportunity to get on the housing ladder if you're a believer.
Making money through trading goods is fine under Shari'ah law, provided it is seen as benefiting society, so buying stocks isn't inherently problematic.
However short-selling is seen as harmful, and Muslims following Shari'ah principles will also want to avoid companies that go against their religious beliefs. Financial companies employ Islamic scholars who determine exactly what is allowed, but companies engaged in the following would certainly be avoided:
- Tobacco
- Pork
- Liquor
- Arms manufacturing
- Non-Islamic finance
- Pornography
Investing in Shari'ah compliant ETFs
One sensible option for Fools who also happen to be Muslim who want to start investing is to go down the ETF route.
ETFs are listed shares that spread your money across lots of different companies for a relatively low cost (compared to buying an actively traded fund). Studies have shown that such 'passive investing' has beaten more active strategies over the longer term.
The obvious problem is a devout Muslim wouldn't want to invest in, for example, Diageo (LSE: DGE), the world's largest spirit maker, as a consequence of investing in every share in the index.
The answer is to invest in a Shari'ah screened ETF, which follows not the whole market, but an index of shares excluding undesirable companies.
iShares, the UK's biggest ETF provider, offers three such ETFs. Unfortunately none follow the UK market, which introduces currency issues as discussed below. Also, by investing in these ETFs you've got to accept your returns will deviate from the overall market -- you'll miss out on any banking revival, for instance, although equally you'd have avoided the slump in those shares!
There are two other issues.
Firstly, the base currency is US dollars. The price quoted from a UK broker will be in sterling, but the underlying fund is in US assets, so your return will partly depend on the fluctuating dollar/pound exchange rate.
Secondly, these ETFs seem pretty illiquid. For instance, I attempted to start a trade in the iShares MSCI USA Islamic ETF and was referred to the dealing desk.
iShares MSCI USA Islamic (LSE: ISUS)
- Price: 1,319p
- Underlying currency: US dollars
- Expense ratio: 0.5%
- Yield: 1.38%
- 12 month performance: Up 27.5%
MSCI's Global Islamic Indices reflect Shari'ah investment principles -- and so avoid investments forbidden under Shari'ah law -- but that doesn't mean unfamiliar names from far-flung emerging markets.
Far from it! This ETF tracks the MSCI USA Islamic Index, a market weighted index drawn entirely from US companies, and the ten largest holdings are:
| Company | Weighting |
|---|
| Exxon Mobil | 7.0% |
| Procter & Gamble | 3.8% |
| Johnson & Johnson | 3.8% |
| IBM | 3.7% |
| AT&T | 3.6% |
| Chevron | 3.3% |
| Hewlett-Packard | 2.7% |
| Coca-Cola | 2.5% |
| Intel | 2.5% |
| Pepsico | 2.0% |
It's fair to say some of those US giants are controversial names in certain quarters in the Muslim world, underlining that Shari'ah investments are a financial classification, not a political one.
iShares MSCI World Islamic (LSE: ISWD)
- Price: 1,270p
- Underlying currency: US dollars
- Expense ratio: 0.6%
- Yield: 1.53%
- 12 month performance: Up 36%
The iShares World Islamic ETF goes beyond the US to include companies from more than 20 other markets. As a consequence, it's more diversified than the US-focussed ETF, with only half as much money in Exxon, for instance, and smaller allocations elsewhere:
| Company | Country | Weighting |
|---|
| Exxon Mobil | US | 3.5% |
| BP (LSE: BP) | UK | 1.9% |
| Johnson & Johnson | US | 1.9% |
| Procter & Gamble | US | 1.9% |
| IBM | US | 1.8% |
| Nestle | Switzerland | 1.8% |
| AT&T | US | 1.8% |
| Chevron | US | 1.6% |
| BHP Billiton (LSE: BLT) | Australia | 1.5% |
| Total | France | 1.4% |
The expense ratio at 0.6% is slightly higher than for the US ETF. But currently the slightly higher yield compensates for that, and this ETF has done better over the past year, too.
iShares MSCI Emerging Markets Islamic (LSE: ISEM)
- Price: 1,172p
- Underlying currency: US dollars
- Expense ratio: 0.85%
- Yield: 1.17%
- 12 month performance: Up 91%
As far as I'm aware, there's nothing that says investors following Shari'ah principles can't have a little excitement, and this emerging markets ETF provides that; after collapsing in the bear market, it's soared 91% in the past 12 months!
The top ten holdings:
| Company | Country | Weighting |
|---|
| Samsung | South Korea | 5.6% |
| Petrobras | Brazil | 4.7% |
| Gazprom | Russia | 4.4% |
| Petrobras (different class) | Brazil | 4.0% |
| Vale | Brazil | 3.6% |
| Reliance | India | 3.3% |
| America Movil | Mexico | 3.2% |
| Vale (different class) | Brazil | 3.1% |
| Posco | South Korea | 2.7% |
| Hon Hai Precision Industry | Taiwan | 2.6% |
This ETF is sure to be volatile -- not only because of the emerging market focus, but because of the big weightings in Samsung, Petrobras and Vale.
The expense ratio rises again, to 0.85% this time, which is a smidgeon higher than other emerging market ETFs. The yield is lower than the other Islamic alternatives, too, although all three are relatively low yielders anyway.
More on ETFs:
