Shariah-compliant funds have come to the fore as a trusted gateway for investors who are looking for financial investments that align with their faith-based and moral values. The investor base is expanding as steady economic growth over the years has contributed to increased wealth in the Middle East, giving rise to an increasingly affluent constituency of new investors who are looking for more sophisticated investment choices.
Investors are looking for alternatives to conventional funds, as they seek transparency and more ethical, less risky options. Further, the finance sector in the Middle East is rising in prominence on the global stage as markets are becoming more open to international players. For investment management companies, this burgeoning dynamic represents an opportunity to innovate and launch new Shariah-compliant investment products, catering to the increase in demand.
Looking at how far it has come, Islamic finance has evolved considerably since it was established nearly five decades ago. The first Shariah-compliant fund was launched in the 1990’s, and the first global Shariah-compliant benchmark was launched in 1999 by Dow Jones. But it is only in the last few years that we have really seen rapid growth in investor interest.
Islamic finance assets valued $3.37 trillion at the end of 2020, up from $2.96 trillion in 2019, and S&P Global Ratings believes the industry will expand another 10-12 percent in 2022. While banking assets and the sukuk market make up the majority of global Islamic financial assets, the Shariah-compliant funds segment has garnered a lot of attention, ending 2021 at $120 billion in assets under management with annualised growth of 13 percent over a five-year period according to Fitch Ratings.
Contributing to this growth is the rise in the range of Islamic exchange traded funds (ETFs) from managers in the US and Europe as well as Saudi Arabia, the UAE and elsewhere in the Middle East.
For a fund to be Shariah-compliant it must be structured in accordance with Islamic principles, which are based on a variety of exclusionary factors. The fund must not invest in any businesses whose activities would be considered harmful or exploitative, and as such do not have a negative impact on society or the environment.
Shariah-compliant funds essentially fall within a category of socially responsible investing, with some taking an extra step further to focus on sustainability and support efforts to mitigate the impact of climate change. As investors around the world have started to factor sustainable considerations in their investment solutions, we can see further potential demand for Shariah-compliant investment products, which by their nature align with responsible, social, and ethical values.
To many market players, these values ring true to their own. Investors today screen out or eliminate sectors, industries or companies based on their beliefs and remove those investments that do not align. And although the Islamic finance market has seen remarkable growth over the last two decades, there remains a lack of diversity in product offerings to meet the increased demand by these investors. One market that has risen to the challenge is the exchange traded funds market.
The ETF market is fast-growing, with global investor demand skyrocketing over the past year alone. ETFs are reputed for being simple, lower cost, efficient investment vehicles that make it easier to gain exposure to diverse products, driving investor appeal. Transparency has always been one of the main benefits of the ETF structure, with the full list of holdings published daily on the issuer’s website and a clear index methodology that enables investors to understand what will and will not be included in their fund. Most ETFs are passive investments, meaning they aim to track the performance of an underlying index or asset.
For Shariah investors, there exist groups of ETF product options that comply with Shariah principles and allow investors to gain exposure to specific markets, sectors, or asset classes. These options range from investing in specific commodities such as gold or silver where the ETFs are backed by the physical commodity, to ETFs that follow certain themes such as technology and blockchain or climate change and clean energy.
As an investment management industry, we are moving in the right direction to broaden the range of Shariah-compliant ETF products available. There have been recent launches on both international and regional exchanges that provide investors with exposure to specific countries or specific sectors, and the outlook shows positive signs of more thematic Shariah-compliant ETFs on the horizon.
However, the choice for Shariah investors looking for broad global exposure without having to research and select targets from thousands of individual stocks and bonds has been limited so far, with combined assets under management of less than $500 million today. There are only a handful of suitable global UCITS ETFs in the market today for Shariah investors managed by global houses like Invesco, leaving significant room for growth.
Looking ahead to the future of Shariah-compliant ETFs we are likely to see a greater appetite for diversification across markets – funds that select their constituents from a whole universe of developed market companies, while addressing key considerations such as income treatment and investment oversight in addition to low annual charges. This represents a new era of global access to a well-regulated investment framework of standards that can offer investors unparalleled transparency, clear guidance, and a gateway to ethical investing.
Zainab Kufaishi, Head of Middle East and Africa, Invesco.
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