How Do Shariah-Compliant Funds Perform In An Uncertain Economy?
There’s a lot to like about Sharia-compliant funds, even if you’re not a Muslim. They focus on socially responsible investing, which can also attract investors who do not want to participate in harmful or unethical industries.
That’s not all: investing in Sharia-compliant funds can outperform conventional funds in times of volatility, like today. Here’s how the current economic uncertainty has affected Sharia compliant funds and why you might want to consider them in your wallet.
But first, what is a Sharia compliant fund?
A sharia-compliant unit trust fund adheres to the principles of Islamic finance. Like a conventional unit trust fund, it pools the money of many investors to buy a group of investments. He can invest using a particular strategy (such as investing in growth stocks or focusing on investments that generate constant income). A fund can also be structured to focus on short, medium or long term returns.
What do Sharia compliant funds invest in?
Sharia-compliant funds differ from conventional funds in terms of investments. While conventional funds can invest in any industry, Sharia-compliant funds undergo an additional level of screening to filter out industries that are not Sharia-compliant. This applies to industries considered unethical, such as alcohol, guns, adult entertainment and gambling. They can also be evaluated according to whether they are Maslahah (serving the public interest).
Sharia law also prohibits excessive interest, uncertainty or risk. As such, Sharia-compliant funds cannot engage in transactions involving short sales, speculative trading, or conventional insurance. This also applies to most bank stocks, which are not considered Shariah compliant because banks derive their income from riba (interest)
Each investment must also meet certain requirements. For example, a stock cannot be considered Shariah if it owns more than 33% of debt securities out of its total assets, because Islamic law prohibits having excessive debt.
What economic challenges have they faced this year?
The COVID-19 pandemic has severely affected businesses and livelihoods. The unemployment rate rose to 5% in April, the highest in 30 years (source: https://www.theedgemarkets.com/article/malaysia-unemployment-rate-spiked-5-april). More than 30,000 small and medium-sized enterprises (SMEs) have gone out of business since the implementation of the movement control order in March.
This economic recession has affected both Islamic and conventional investments. According to a recent study that examined the stock exchange from December 31, 2019 to April 18 of this year, the COVID-19 pandemic has had a significant negative effect on the KLCI, as well as on all sectors except the plantation sector. (source: http: //www.ijbs.unimas.my/images/repository/pdf/Vol21-no2-paper7.pdf). In March, the KLCI fell to its lowest point in a decade, although it has since risen (source: https://www.theedgemarkets.com/article/klci-sinks-below-1300-mark-its -lowest-decade).
We’re not out of the woods yet either. The COVID-19 pandemic is still affecting our daily lives, while there are political uncertainties both locally and abroad. These factors make it difficult to predict how the stock market will perform in the short term.
Are Sharia Compliant Funds More Stable Than Conventional Funds?
Although economic recessions have affected both Islamic and conventional funds, the effects are not the same. During times of uncertainty, such as today, Islamic funds have historically performed better than their conventional counterparts (source: https://www.theedgemarkets.com/article/islamic-investments-more-stable-choice-uncertain- times.
Let’s take a look at how stocks performed during the SARS outbreak in 2003 and the global financial crisis of 2008-2009. From January 2002 to July 2012, the Dow Jones Islamic Market Index (which tracks the performance of Sharia-compliant stocks in the United States) outperformed its conventional counterpart, the Dow Jones Industrial Average Index, by 14.26% (source: https: // www .theedgemarkets.com / article / Islamic-investments-more-stable-times-uncertain).
Closer to home, here’s how the FBM KLCI, which tracks the 30 largest companies in the Malaysian stock market, performed against the Principal Islamic Malaysia Opportunities Fund, which invests in sharia-compliant stocks and sukuk.
1 From January 1 to November 10; http://www.bloomberg.com/quote/FBMKLCI:IND
2 From January 1 to November 9; https://www.bloomberg.com/quote/CIMIAAE:MK
Disclaimer: We recommend that investors read and understand the contents of the prospectus of funds and product sheets (PHS) available on the main website which have been duly registered with the Securities Commission Malaysia (SC). Recording of these documents does not imply or indicate that the SC has recommended or approved the product or service. Investing in funds involves risks, costs and charges. We suggest that you understand the risks involved, do your own risk assessment and seek professional advice, if necessary. This article has not been reviewed by the SC.
However, that doesn’t mean that Sharia-compliant funds always work better than conventional funds. In times of uncertainty, Sharia-compliant funds may offer more stability as they tend to be less volatile. But on top of that, conventional and Sharia-compliant funds usually offer similar returns. For example, here’s how the leading Islamic Lifetime Balanced Fund compared to its conventional counterpart over the past five years: Why do Sharia-compliant funds tend to perform better in times of economic instability? Well, due to Sharia filtering requirements, they are generally not exposed to volatile stocks like banks. In contrast, conventional funds are exposed to bank stocks, which were hit hard during the recession. The cut in the overnight policy rate (OPR) and the introduction of moratoriums on lending resulted in lower profit margins for banks, which in turn affected their share prices. Financial services stock prices fell 21% from the start of the year to November 9 (source: https://www.bursamalaysia.com/trade/trading_resources/listing_directory/indices-profile?stock_code=0010I) .
Source: Lipper Analytics; September 15, 2020
Choosing the right funds matters in the long term
In short, Sharia-compliant funds can be a good investment choice for Muslims or for those who value socially responsible investing. In times of uncertainty, they may also outperform conventional funds.
While Sharia-compliant funds can help provide more stability in the short term, it’s also important to choose the right funds to make your money grow in the long term. This means choosing funds that can perform well, as well as those that match your risk profile.
Principal Islamic Asset Management, one of Malaysia’s largest Islamic asset managers, has global experience and expertise. You can choose from a wide range of Shariah Compliant Funds that cover different asset classes, geographies and risk ratings – this means being able to create a Sharia portfolio that meets your needs and helps you achieve your long-term investment goals.
Looking for Sharia Compliant Investments? Learn more about investing in Sharia-compliant funds with Principal.
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