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Broader ESG Lessons From Embracing Islamic Finance

Naushad Virji of ShariaPortfolio lays out what advisors need to consider to win clients with specific needs.

By Naushad Virji

In recent years, there has been a strong uptick in the number of clients interested in impact investing. But, the universe of investment filters according to environment, social and governance factors is vast and just as diverse as clients who want their portfolios to be an extension of their beliefs.

Tackling that universe as a whole is daunting and might be impossible for some advisors. However, developing expertise in one or more areas can help an advisor deliver specific investment needs and turn impact investing into a differentiator.

ShariaPortfolio, the firm I founded in 2003, has done this already and the firm’s expertise in creating portfolios compliant with the interests of American Muslims can serve as an example of what advisors need to consider when identifying and catering to a specific group.

American Muslims are an often overlooked, albeit growing, segment of investors. According to a 2017 Pew Research Center study, observant American Muslims now make up about 1.1 percent of the U.S. population. Still, they’re a favorable group of clients for advisors. 

Their economic profiles show the community to be slightly more likely than non-Muslim workers to be engaged in professional careers and as likely as other Americans to earn annual incomes in excess of $100,000. It’s still relatively small, but the U.S. Muslim population is also growing rapidly, and advisors who aren’t prepared to provide these investors with appropriate options may miss out on valuable opportunities.

The same could be said for other groups of investors who want their portfolios to adhere to certain ESG factors. Those groups might be relatively small, but that could mean there’s opportunity for an advisor to serve their needs at a level that others can’t.

Know What a Specific Group Needs—Even Better Than They Do

Investors generally come to an advisor with ideas or philosophies they want their portfolio to abide by. It’s then up to the advisor to be the expert, and if they can execute on the client’s requests, they will win their business.

In our firm, our clients are practicing Muslims and we’re experts in managing their portfolios in accordance with Sharia, or Islamic law. Compliant investments are Halal, meaning they are lawful and permissible under Islamic guidelines, while anything that’s forbidden or religiously sanctioned is considered Haram.

To be Sharia compliant, companies and investments need to pass several screens. In terms of permissible asset classes, only stocks and Islamic exchange traded funds are eligible for Sharia-compliant consideration; preferred shares are considered non-compliant. A business activities screen excludes companies that derive more than 5 percent of their total income from non-compliant income sources, including “sin” industries such as alcohol, tobacco, weapons, gambling and pornography, along with pork products, music and cinemas or broadcasting.

Less obvious to many advisors, perhaps, is that conventional insurance, interest income, and conventional financial services are also considered Haram. This is because Islam views money as a tool to be used in business transactions and not as a commodity to generate profits. Debt instruments therefore are non-compliant. Investing in conventional insurance is prohibited because, like gambling, the industry involves a high level of uncertainty. For the same reason, speculative trading in shares, short-selling, trading in derivatives, or trading in unidentified items are also prohibited.

Islamic finance operates more along the lines of risk-sharing, as opposed to placing most or all of the risk on one party, and certain ratios must be met for a company to be Sharia-compliant. For example, interest-bearing debt over a 12-month average market capitalization should be less than 30 percent; the same holds true for cash, cash equivalents and short-term investments.

Advisors Must Be Familiar With the Alternatives Themselves

Beyond working with a wealth manager, advisors need to be familiar with the alternatives available to a client. It’s pertinent that an advisor is capable of explaining advantages and disadvantages of solutions that might fit their needs in helping them make the decision that is right for them.

The rules governing Islamic finance and investing are highly complex, addressing a range of needs from charitable giving to permissible mortgages. Clients seeking Sharia-compliant options could open a brokerage account and manage their own assets, invest in a robo advisor that only invests in Sharia-compliant investments, buy Sharia-compliant mutual funds or work with a financial professional.

It’s also important as an advisor to understand their limitations. If they’re unable to become an expert in a field that their client wants to comply with, or simply don’t have the time, there are options out there. For example, we work with advisors who don’t know all the ins and outs of Sharia-compliant investing. So, we can actually co-manage a client’s account to provide them with Sharia-compliant solutions they might not otherwise get from their advisor. This ends up being a win-win solution for the advisor who doesn’t need to become an expert in Islamic finance and the client who can invest according to their needs and stay with the advisor they’ve come to trust over the years.

Clients and Advisors Need to Be Aware of Benefits and Drawbacks to ESG Portfolios

Constructing a Sharia-compliant investment portfolio may bring the investor closer to that ideal of doing well by doing good. Investors can avoid socially and environmentally harmful companies and promote socially beneficial enterprises. They can also avoid risky allocations to highly leveraged instruments. In fact, the benefits of this approach were revealed in the financial crisis of 2008-2009, when Halal investors weathered the storm in relative safety. Because of this, it comes as no surprise that many non-Muslims find Sharia-compliant investing to be an ideal way to hedge against leverage.

However, there are potential drawbacks to ESG portfolios and the advisors putting them together. Because these portfolios conform to a client’s personal values, there may be less diversification, so it’s important to consider alternative options for your clients, such as investing in real estate or commodities. For the advisor, there may be a learning curve to becoming an expert in the area of interest to a specific client, and that could mean hours of research on the topic as well as figuring out complex solutions.

It’s important to be aware of both the benefits and drawbacks to ESG portfolios, and the advisors that can navigate these subjects will become differentiated from their peers. 

Naushad Virji is the founder and CEO of ShariaPortfolio, a boutique asset management firm specializing in Sharia-compliant investing. For more information, visit https://shariaportfolio.com.

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