What can Shariah-complaint investing teach you about ethical investing?

Shariah-compliant investing is based in the principles of Islam. This means that Shariah-compliant investments won’t be used to fund activities which are incompatible with an Islamic lifestyle, such as the manufacturing and distribution of alcohol, pornography, or gambling.

However, it’s not just available to Muslims. In fact, a growing number of non-Muslims have been turning to Shariah-compliant investing in recent years to improve the ethical profile of their portfolio, while also targeting steady returns which are often uncorrelated to the wider market.

Most large financial institutions now offer Shariah-compliant investment options. These may range from specially selected stocks and shares, to Shariah-compliant funds, and even opportunities to lend money in a Shariah-compliant manner.

What is Shariah compliance?

Shariah compliance involves investing in line with the Muslim faith. This means adhering to halal (allowed) principles and avoiding anything that is haram (forbidden).

Mainstream finance is often considered haram as it involves the collection of interest on loans (known as riba) and its payment to other lenders or investors. Making money from money is forbidden in Islam, but there are a few workarounds which make it possible to maintain Shariah-compliant investments in lending products and insurance.

Some of the financial instruments which are forbidden under Islamic law include:

• Collecting riba or interest on loans or late payment fees
• Businesses that are haram or haram-adjacent. This includes businesses which profit in any way from alcohol, pork, gambling, pornography, weapons, tobacco, and other sectors
• Speculative investments, which can be classed as gambling under Islamic law
• Derivatives and futures, which invoke the principle of gharar – a term that roughly means ‘uncertainty’ or where the buyer does not know the outcome of what has been bought

When all these variables are removed, you will be left with a relatively lean investment portfolio with an emphasis on tangible assets.

It’s worth noting that Shariah-compliance can be open to a certain amount of interpretation. Islamic finance houses employ their own panel of Shariah scholars who judge each investment opportunity based on their own interpretation of Islamic teachings.

How does Shariah-compliant investing align with ethical investing?

Ethical investing is all about avoiding investments that do not align with your values. This can be as simple as avoiding options that make money from conflict, backing options that support environmental recovery, or following an approach that aligns with your personal faith.

For some ethical investors, Shariah-compliance offers everything they are looking for in an investment strategy. By investing in a Shariah-compliant fund, they know that their money won’t be used to fund weapons of war, or to support unethical businesses such as Big Tobacco.

Shariah compliance is a form of negative screening – if a potential investment does not meet the standards of admission for a fund or portfolio, it’s not getting in. This obviously requires a lot of due diligence by a panel of experts, so many Shariah-compliant investors prefer to place their money into managed Islamic funds rather than going through the hard work of self-selecting their own investments.

Funds will often have a dedicated, transparent board that will make rulings on an investment’s suitability, with any reasoning clearly provided to fund members. This board will be made up from dedicated scholars and practitioners, to further add legitimacy and insight.

What are the returns like?

In many cases, ethical investing involves prioritising morals over returns, but they can still be profitable for investors. However, you are unlikely to make astronomical returns from a Shariah-compliant investment due to the very conservative nature of these portfolios. Shariah scholars typically choose to focus on well-established businesses which have passed their high-growth phase and are focused on delivering value for shareholders. This means that returns are likely to be lower but with minimal volatility.

Shariah investments also tend to do better over a medium-to long-term investment horizon, when compound interest has a chance to kick in. If you’re able to avoid any major losses, and as long as you are reinvesting any interest earned, you are likely to see good results from your portfolio over a longer period of time.

In fact, some studies have even found that Shariah-compliant funds returned more than their global peers over the past five years, thanks to the impact of consistent annual returns.

Of course, Shariah-compliant investing will not be for everyone, and there are many other ways to seek out ethical investing options beyond the world of Islamic finance. But as Shariah-compliant investing becomes more mainstream, it’s coming to represent an accessible and lower-risk way to reshape your portfolio away from so-called ‘sin stocks’ without performing a mountain of due diligence on hundreds of individual stock options. As always, do your research before making any new investment, and always ensure that your investment portfolio aligns with your individual risk profile.