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Evaluating Islamic Investment Standards
Islamic investing has evolved from niche to mainstream
BY MONEM SALAM AND STEPHANIE ASHTON
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mutual funds have proven to be an effective investment solution for Muslim investors. Not only do they foster partnership in shared risk and reward (musharaka), but they also provide an ideal vehicle to diversify assets while avoiding haramindustries. This exclusionary screening, characteristic of Islamic and other faithbased mutual funds, is the primary method used to pursue values compliance. In times of crisis, Islamic screens have also provided — to investors of all faiths and of no faith — some buffer from high market volatility. In any economic disruption, certain industries are more susceptible to negative performance relative to others. During the 2008 financial crisis and most recently in the Covid-19-related “crash” in March, Shariacompliant screens helped funds avoid some of the worst-faring industries. During the ongoing pandemic, hotels, restaurants, leisure, airlines and financial services have tended to do worse due, in part, to negative consumer sentiment or because they carried a high debt load. Airlines, for example, tend to carry a high percentage of debt and therefore don’t meet Sharia-compliant financial screens. Given that industry’s exposure to interest, similarly Islamic screens exclude banking. Between the recent sell-off of financial stocks (as investors feared potential damage from missed loan payments) and the extreme decline in air travel since March, Shariacompliant funds have been largely shielded from these losses. The hospitality industry has also suffered tremendously. Many stocks have booked their highest losses in history, falling an average of 22% more than the S&P 500. But hospitality, too, is typically excluded from Islamic portfolios because it cannot pass the 5% haram revenue threshold. By avoiding exposure to alcohol- or gambling-derived revenue streams, Islamic-compliant funds have been insulated from the hotel, cruise
Over the last four decades,
line and restaurant industries as well.
ISLAMIC SCREENING IN GREATER DEPTH
While Quran 2:275 encourages trade and investment and guides Muslims on how to approach these activities, formalized financial processes only began to develop in the mid-20th century. As the modern Western financial system grew, banks operating according to Islamic principles popped up as a way to avoid riba (interest), gharar (speculation) and investments in industries engaging in haram activities.
When Malaysia launched the first Shariacompliant mutual fund in 1979, the guidelines for Sharia investing were far from standardized. When the second Sharia-compliant fund was launched in the U.S. during 1986 — the Amana Income Fund — there still were no formal guidelines for investing practices. The 1990 meeting of several Islamic financial institutions, out of which emerged the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI; aaoifi.com), finally developed and issued industry standards. It currently has members from more than 45 nations working among several areas of finance.
Although it was formally established by 1991, the AAOIFI was already somewhat late to the game, for investment vehicles worldwide had been operating successfully under a variety of guidelines for years. Because applying interpretations of Islamic law to business activities is nuanced and halal investment guidelines can vary, financial institutions are advised to rely on guidance from Islamic scholars to help determine whether an investment is halal. That being said, there are some basic standards. • Debt. One goal of a Sharia-compliant portfolio is to have as little conventional debt as possible: The less conventional debt carried by the issuer, the better. Islamic financiers originally looked for issuers with zero debt, but that limited the universe of investment
