Investing with goodness

The increasingly louder call to action around stewardship and sustainability in business and investment management is encouraging and grounded in a substantial body of scientific evidence. Camissa Asset Management’s thorough and ongoing research process is dedicated to dynamically integrating responsible stewardship into practice across all arms of the business.

While best practice in business is increasingly shaped around sustainability, reality has pushed geopolitical risks into the spotlight as key determinants of investment decision-making, alongside environmental, social and governance (ESG) considerations. In discussing how geopolitics and ESG impact Shari’ah investing specifically, we investigate the synchronicities that exist within the fundamental principle of avoiding harm. How can this orientation result in conscious decision-making and, in turn, superior investment performance amid volatile market conditions?

Islamic securities – a safe haven?

Islamic finance is a principles-based approach to investing, designed to ensure compliance with recognised Shari’ah principles and the stability and sustainability of the investment. Shari’ah-compliant funds, governed by the requirements of Shari’ah law and the principles of Islam, are considered to be socially responsible investments. While often thought of as only for investors who follow the Islamic faith, there is a growing attraction from a cross-section of investors looking for exposure to more ethical investments.

Abdul Davids Head of Research – Camissa Asset Management

The integration of ESG into this investment approach appears to be a natural one, as common values are shared through the higher objectives of Islamic law and the preservation of life, resources and the environment. As with ESG investing, the approach is a long-term, low-volatility risk reduction strategy that applies to all investors.

Camissa’s process is in alignment with the principles of ESG investing, buoyed by our focus on a keen understanding and analysis of the key drivers of cash flows. This keen understanding is coupled with a concomitant risk analysis, which applies probability theory to various credible scenarios that could impact a company’s cash flows. We believe that our team of analysts are best positioned to form a holistic view of investment merits, including ESG considerations, by applying our thorough research process.

Geopolitics sets back sustainability goals

With climate change and a global humanitarian crisis in the spotlight, it is no surprise that the practice of investing responsibly through ESG has developed at an increasing rate over recent years. Yet, geopolitical instability threatens the four dimensions of sustainability upon which ESG goals are founded, namely economic, environmental, social and governance factors.

The current war in Ukraine represents the most recent example of a test for a socially responsible investment movement. It has already cost great loss of life, displaced millions of people from their homes and tested the endurance of health, housing and education systems. Rising commodity prices and trade disruptions exacerbate inflationary pressures, which could force millions of people, especially the most vulnerable, further into poverty. Moreover, in the face of the weaponisation of gas, this war could even expedite the global transition to a cleaner, more sustainable energy future.

Inevitably, geopolitical sustainability will be questioned, surely leading to a reassessment of ESG investment approaches towards sustainable portfolios – a concept that has already been an essential consideration for Shari’ah investment law since the advent of modern Shari’ah investing in Malaysia in the 1960s.

Risk reduction through ethical investment

Shari’ah-based rules around ethical investing, together with requirements on risk sharing and asset backing, limit risk in Shari’ah-compliant investments – particularly during periods of geopolitical and economic stress and volatility. Shari’ah restrictions on the maximum amount of leverage have played a key role in the outperformance of Shari’ah-complaint funds compared to conventional funds during the 2008/2009 financial crisis.

For the universe of asset managers participating in the Alexforbes Shari’ah survey, compliance in Shari’ah investing is governed by the international corporate body, The Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI). Investment rules are qualitative (no sin stocks) and quantitative

Good will triumph

(avoidance of too much debt or leverage). The Shari’ah investment mindset is focused on responsible behaviour, which in itself is founded on a strong portfolio risk management process that dynamically incorporates ESG:

• Research entails a thorough due diligence process with a strong focus on the valuation of cash flows. The material ESG risks and opportunities (often using a score process) are evaluated per company. These are focused on the materiality per sector to compare companies to competitors in the same industry, with a similar ESG risk profile. Our probabilistic framework is well suited to analysing various alternative scenarios and identifying asymmetries.

• Activism takes place via informed shareholder voting and active engagement with companies on material ESG issues. Here, we leverage off our expertise and focus on areas where the most value can be delivered.

• Portfolio construction incorporates ESG factors during this process where we:

• manage specific risks through limiting ownership in each company

• diversify across key drivers, sectors and stocks

The significance of ESG factors in Camissa’s analysis of risk and growth opportunities supports the time and effort committed to the process of incorporation. Furthermore, focusing on the future cash flows of companies enables our analysts to steward the investment process and remain best placed to incorporate ESG into the research process. We believe this offers a key competitive advantage, as a separate ESG team may not have a direct link to idea generation, which leads to portfolio construction and, ultimately, performance.

While there are certainly differences between ESG and Shari’ah investing that hinder total convergence in practice at present, ethical investing form is built on a strong foundation. When faced with the added impact of geopolitical risks and risks associated with high leverage, decisions rooted in a values-driven, sustainability-focused, risk-measured approach would soften the blow. They could also spark renewed confidence that may cause a beneficial ripple effect through the investment industry at large.