FEATURE SHARIAH INVESTING
31 December 2019
RAYHAAN JOOSUB Portfolio Manager, Sentio Capital Management and IMTIAZ SULIMAN, CFA Portfolio Manager, Sentio Capital Management
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ne of the biggest challenges in the Shariah world is managing risk. Given the concentrated nature of the local equity market, Shariah investing is considered high risk in South Africa. This is in contrast to the global arena where Shariah funds are viewed as a relatively safe option. Why is Shariah investing viewed as risky in SA? The FTSE/JSE Shariah index is built off the FTSE/JSE ALSI, which in itself exposes investors to concentration risk by virtue of the domination of a number of large companies and sectors. Shariah restrictions include avoiding interest-charging entities, companies that hold more than 30% of total assets in either debt or cash, and those that engage in what Shariah law views as socially harmful
activities like gambling, alcohol and weapon manufacturing, for example. These restrictions whittle down the FTSE/JSE ALSI to a mere 74 stocks that are Shariah-compliant. Furthermore, four stocks – MTN, Sasol, Anglo American and BHP Billiton – make up about two-thirds of the Shariah index, so there’s very high single stock concentration. There is also high sector concentration because resources make up around 50% of the index (including Sasol). South African Shariah funds therefore tend to closely track the performance of the resources sector. The Shariah index has a significant style bias to cyclical value stocks too. Shariah equity funds are therefore less diversified and, as a result, riskier than your typical, non-Shariah equity fund in the South African setting.
Risk management is Shariah's greatest hurdle
What is risk? At this point, it is worth considering what risk really means. People generally overestimate their ability to recognise risk and underestimate what needs to be done to avoid risk. As such, they accept risk unknowingly and contribute to its creation. We define risk as the likelihood that we will receive a return that is different from what we expect, whether that return is better or worse. Bear in mind that higher-thanexpected returns represent a risk if they are a result of luck rather than skill. To translate risks into opportunities, we advocate pricing risks appropriately. For example, the position size of a stock that enjoys stable earnings, cashflow and dividends but a middling expected return should be different to the position size of a stock that scores poorly on these metrics but has a high expected return.
Overcoming the risks inherent in Shariah investing None of this is to say that a Shariah investor needs to take on these risks. There are ways that an asset manager can lower risk. Firstly, it is essential to have an unbiased mechanism such as a robust portfolio construction process to identify and control for unintended bets. Secondly, incorporating nonvalue factors like growth and quality will offset your style exposure risk. Investing in sectors outside of resources will lower your concentration risk, as will looking abroad to global assets. These not only provide better dimensionality than investing purely in the domestic universe, but also improve diversification. We believe this incorporation of global assets is a key contributor to a portfolio’s competitive performance.
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How to invest in MSCI World Islamic Index companies
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omentum Securities has launched a Global Shariah Portfolio providing South African investors access to an international Shariah aligned investment opportunity for a minimal initial investment amount of R5 000. This portfolio invests in companies contained in the MSCI World Islamic Index (USD), which is also the portfolio’s benchmark. “Investors can gain access to this portfolio via an exchange traded note (ETN) listed on the JSE, which invests directly in the Global Shariah Portfolio,” says portfolio manager Francois Strydom. “This means that investors gain offshore exposure without having to utilise their offshore allowance.” Momentum Securities will furthermore ensure that all dividends, interest and management fees are included within this single instrument listed on the JSE. “At Momentum Securities we select companies and analyse them both in isolation and in context of the macro environment in which they operate, enabling our investment teams to determine what value to place on securities’ growth potential. This investment process assists us in finding stocks that trade below their intrinsic value, generate more
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reliable cash-flows, and ultimately provides us with a competitively performing portfolio,” adds Strydom. “Our investment management process therefore appropriately gears us towards applying Shariah investment principles to our existing asset management process. This is done on a bespoke basis by excluding securities utilising two types of criteria: business activity and financial ratios,” Strydom continues. Strydom explains that excluding companies based on business activity, this portfolio refrains from investing in companies that are directly active in or derive more than 5% revenue from the following activities: alcohol, tobacco, pork-related products, financial services not regarded as Islamic financial institutions, defence/weapons, gambling/casinos, adult entertainment, music, hotels and cinema. No shares outside of the MSCI World Islamic Index may be included in the portfolio and Momentum Securities will not conduct dividend purification.
“The fund is high conviction, invested in approximately 20 different companies in the healthcare, information technology, consumer-non-cyclical, industrial and real estate sectors. A third of the fund is currently in cash, which enables us to take advantage of any investment opportunities we identify. “Ultimately, this fund is targeted at individuals looking for global equity exposure to the MSCI World Islamic Index universe with a minimum of a five years investment horizon. As with all investments that are higher risk, we encourage investors to seek advice before making any investment decisions,” Strydom adds.
Francois Strydom, Portfolio Manager, Momentum Securities
