Islamic Investor: Islamic Investor: - Islamic Finance News

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CHAPTER Benefitting from Responsible Investment Interfacing Shariah Investing with Socially Responsible Investments (SRI) and Environmental, Social & Governance (ESG) In June 2006, legendary investor Warren Buffet, announced he was giving most of his wealth to the foundation set up by Bill Gates and his wife. The total assets of the Bill & Melinda Gates Foundation are expected to reach US$100 billion before the end of the decade. As societies become more affl uent, they experience a migration of values. There appears to be a shift away from “materialist” values, which emphasize economic and physical security and towards “post-materialist” values, which emphasize selfexpression and quality-of-life. Data shows that the top 2% of the world’s population owns more than half the world’s wealth, and the top 10% owns 85% (Source: World Institution of Development Economics Research, 2000). The future of the social-issues movement hinges on the desire of the wealthiest individuals of the planet to use their investments to improve the world. The good news is that this desire exists. Even the smaller “Average Joe” investors believe that the small gestures they make to avoid harming the environment makes them feel better. They are able to see concretely what their savings are used for: which companies get their money and what they do with it. This new breed of investors consist of people who care deeply about ecology and saving the planet; about relationships; about peace and social justice; and about self-actualization, spirituality and self-expression. The concept of assimilating ethical components into investment portfolios has always been the core of Shariah investing. Shariah investing can be considered a form of socially responsible investing (SRI) because it also excludes investment in businesses that are deemed unethical, such as those involved in gambling, alcohol, tobacco and weapons. Interestingly, Shariah investing then goes beyond the traditional ethical investment screening approach to further integrate an Source: MSCI, August 2011 additional layer of risk management with SRI ethical screening. The Shariah–compliant investment process exercises prudence by excluding investments in highly leveraged companies from the portfolio. The screening process reinforces the principle that acceptable Shariah-compliant stocks should not be involved in excessive risk taking, high borrowing, or exploitation of contracts. This investment approach is arguably more fi scally ethical as it screens out fi nancially-risky stocks for a more stable and prudent alternative investment style. Overall, a Shariah-compliant portfolio will be less exposed to the following: 1) De-leveraging; 2) Insolvency; A Comparison of MSCI Islamic, ESG and SRI Indices and methodologies Islamic; environmental, social, and corporate governance (ESG); and SRI funds were some of the investment innovations that have been adopted since the 1980s, according to the recent fi ndings of a global survey conducted by CREATE- Research. Fundamentally designed to deliver psychological benefi ts, these “themed” funds appeal to investors who are seeking investment solutions that are not only harmonious with their beliefs, but also have shown comparable performance to conventional investing. For these investors, free markets often meant the organized exploitation of the weak by the strong. The MSCI World indices provide Islamic and values-based indices to cater to this market. Its Islamic Index Series Methodology applies stringent screens to exclude securities based on business activities, as well as fi nancial ratios derived from total assets. Meanwhile, the MSCI Socially Responsible indices exclude companies that are inconsistent with specifi c values-based criteria. Additionally, these indices target companies with high ESG ratings relative to their sector peers, to ensure the inclusion of the best of class companies from an ESG perspective. Let us examine how these index methodologies have performed against one another as well as against the mainstream indexing approach (represented by the MSCI World Index). In the price comparison chart below, the returns for the MSCI World SRI, MSCI World ESG, and MSCI World Islamic Index all outperform the conventional MSCI World Index. Interestingly, during the 2008/2009 global fi nancial crisis, the MSCI World Islamic Index outperformed the other three indices. Relative to the MSCI World SRI and MSCI World ESG indices, the Shariah index has fewer constituents because of the nature of the rigorous screening and analysis adopted, the most obvious being the exclusion of the fi nancial sector. The MSCI 22 September 2011
CHAPTER World Islamic Index’s outperformance of the other two indices is clearly evident over the period of the abovementioned downturn while the MSCI World ESG trails that of the conventional MSCI World along an almost identical path. This is despite the fact that more than 50% of index constituents in the MSCI World Islamic Index are also constituents of the MSCI World ESG Index. The MSCI World ESG and MSCI World SRI indices’ constituents overlap a fair amount with those in the MSCI World Islamic index: Out of 630 Islamic constituents, 356 are found in the MSCI World ESG index and approximately half of the market weighting of the MSCI World SRI index corresponds to constituents found in the Islamic index (Source: MSCI, September 2011). Despite MSCI’s ethical indices having a similar industry screening methodology between MSCI’s ethical and Shariah indices, the latter has clearly proven to be not only more resilient during a down trending market, but also less volatile. Source: MSCI, August 2011 While naysayers may argue that Islamic indices only build alpha during a downturn, the graph clearly continues to show outperformance by the Islamic index compared to the ESG and mainstream world indices during the period of April 2009 up to August 2011. The comparative returns of all four indices have proven that the Islamic index is more resilient and continues to build alpha even after the markets have stabilized. We believe that the two major factors that could contribute to this outcome are: 1) Minimal country weightings for the debt-ridden PIIGS (Portugal, Italy, Ireland, Greece, Spain). These Eurozone countries were on the verge of fi nancial ruin by the beginning of 2010 and greatly contributed to the European sovereign debt crisis. The MSCI World Islamic index weighted these countries at only 1.1%; the conventional World weighted them at 3.0% and the ethical indices weighted them at approximately 4.0%. (See Exhibit 2) 2) The relative overweighs for health-related securities and underweights in the cyclical consumer discretionary and fi nancials sectors of the Islamic index also could contribute to the outperformance. (See Exhibit 3) Source: MSCI, August 2011 Conclusion The comparative analyses between Islamic, SRI, ESG and conventional indices tend to show that the Shariah-investing approach results in a higher cumulative performance coupled with lower volatility, not only during an economic downturn but also, apparently, during an economic recovery. Its resilience and its continued momentum through the economic recovery demonstrated that the Shariah-investing approach is a viable long-term alternative to conventional investment. Despite the basic purpose of these types of investments which encourage social responsibility and good governance, Shariah investing remains a more formal system that provides additional prudent fi nancial guidelines. These guidelines, when compared with traditional socially responsible investment, are consistent with ethical fi nancial practices and sharing, both in approach and objective, but they do not preclude compatibility with other SRI approaches. As long as these approaches do not conflict, they can not only be compatible but complementary, with the integration of SRI and ESG criteria offering both ethical and financially prudent guidelines as an added value. The success of Shariah, SRI and ESG investments at present do not seem linked in any way. As at the end of 2005, SRI investments alone accounted for nearly US$2.3 million in just the United States, which is 10% of total assets under management in that country. Nonetheless, financial experts, researchers, regulators, relevant agencies and market players could perhaps provide input on how these investment approaches can be further consolidated to encourage more ethical, responsible and transparent practices. These alternative investment approaches have been evidential in providing comparable risk-returns and can be developed jointly, together with their potential client bases, thus heightening the complementary potential of Shariah and SRI and ESG investments into new markets. Noripah Kamso, Chief Executive Offi cer CIMB-Principal Islamic Asset Management Sdn Bhd (“CIMB-Principal Islamic”). September 2011 23
Page 1 and 2: September 2011 Islamic Investor: Eq
Page 3 and 4: EDITOR’S NOTE Supplements Editor
Page 6 and 7: COVER STORY Equities Vs. Commoditie
Page 8 and 9: COVER STORY futures market to estab
Page 10 and 11: FEATURE investments in Islamic REIT
Page 12 and 13: Global industry One publication Est
Page 14 and 15: FEATURE or country-focused ETFs, wh
Page 16 and 17: FEATURE Source: Eurekahedge conduci
Page 18 and 19: CHAPTER Islamic Hedging & Risk Mana
Page 20 and 21: CASE STUDY Executive chairman of AP
Page 23: STATEMENT Beyond Banking Global Isl
Page 27 and 28: RESULTS Crème de la Crèmé The in
Page 29 and 30: RESULTS Best Asset Management Compa
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