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Islamic-Value Investing: A Closer Look

Our clients and friends have been expressing a lot of interest in Sharia-compliant investing lately, so this week we would like to discuss the topic in greater depth than we did in our June blog posting.

We know that some Muslims have totally avoided investing in the stock market thereby missing out on the economy’s rebound. Accretive Wealth’s mission is to provide financial planning and investment advice that aligns with each investor’s beliefs and values, and we want to offer our Muslim clients ways to take part in economic growth through the markets without contravening Islamic values. Let’s begin by reviewing the basics.

What does Sharia-compliant mean?

Sharia is the moral code and religious law of Islam that observant Muslims follow in their daily lives. It is based on the Quran (the primary religious text of Islam) and on the Sunnah (relying on the teachings and practices that Muhammad followed). Sharia addresses broad social areas such as economics, politics, and crime and more personal areas such as hygiene, diet, prayer, and fasting.

There are liberal and conservative views of what investments are considered to be Sharia-compliant, but none of them allows interest income. This precludes bonds and many types of alternative investments. For the purposes of this discussion, we will use the MSCI Islamic Index Series Methodology, which is the methodology used in our Sharia-compliant portfolios. This methodology was confirmed through a fatwa issued in March 2007 by the Sharia Supervisory Board of Dar Al Istithmar, led by Dr.Hussain Hamid Hassan and made up of some of the most widely respected and distinguished scholars in Islamic finance. Dr. Hassan now chairs the advisory board at Khalij Islamic, which monitors MSCI’s Islamic indexes for ongoing compliance.

Investments are screened for compliance

The MSCI Islamic Index Series Methodology has three screening steps:

  1. Business practices: No company is considered compliant if it derives 5% or more of its cumulative revenue from the following products, services, and activities that are considered to be against Sharia law: alcohol, tobacco, pork-related products, financial services (except Islamic financial institutions), defense/weapons, gambling/casino, music, hotels, cinema, and adult entertainment.
  2. Financial ratio screening: This screen eliminates companies that derive significant income from interest or that have excessive leverage. Three financial ratios are used to further screen these companies: total debt over total assets; the sum of a company’s cash and interest-bearing securities over total assets; and the sum of a company’s accounts receivables and cash over total assets. None of the financial ratios may exceed 33.33%. Market capitalization can be more volatile than total assets, so MSCI uses total assets rather than market capitalization for the three financial ratio screens because it results in lower index volatility and lower index turnover.
  3. Dividend purification: This screen applies a “dividend adjustment factor” to all reinvested dividends by “purifying” them of the portion of total earnings that came from prohibited activities and interest income. (Total earnings are defined as gross income, and interest income is defined as operating and non-operating interests.)

Because investors who wish to be compliant with Sharia law have a limited number of mutual funds to choose from in the US, we reached out to the Aperio Group, a pioneer in applying enhanced indexing techniques to socially responsive portfolios. The Aperio Group has put together two types of separately managed accounts for our clients, both of which follow the MSCI Islamic Index Series Methodology. The domestic option is benchmarked to the Russell 3000 Index, and the global option is benchmarked to the MSCI All Country World Index (MSCI ACWI).

This partnership allows us to offer separately managed Sharia-compliant accounts to our clients with a much lower minimum account size than is usually required. We are also able to add additional screens to serve goals such as social responsibility or tax awareness.

If you’re interested in finding out more about Sharia-compliant or traditional portfolios offered by Accretive Wealth, please call us at (925) 365-1533, or send an e-mail to lifeplan@accretivewealth.com.

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