What is Shariah investing?

Shariah is a set of Islamic principles governing all aspects of the day-to-day activities of Muslims.

Shariah investments comply with these principles. These investments and other Islamic financial products that adhere to Shariah laws are largely self-governed.

Financial products that are Shariah-compliant have a moral and ethical foundation that is lacking in Western-style capitalist economies, where regulators must impose legislation to curb excesses and unfair business practices.

While aimed primarily at Muslim people, Shariah investing also appeals to non-Muslims who are looking to invest in an ethical and socially responsible way.

What Shariah principles are followed?

Islamic investing adheres to the following fundamental principles:

• Risk and reward must be equitably distributed between lender and borrower or between investor and investee (the entity into which the investment is made).
  
  
• When money is lent, charging interest at a fixed rate on the capital (“riba”, which literally means “excess”) is forbidden as it favours the lender. This is contrary to the Western idea that money has a “time value”.
  
  
• You cannot invest in businesses that are prohibited by Shariah. These include:
  
  
  • Conventional financial institutions that charge or pay interest;
    
    
  • Businesses involved in socially harmful activities, such as gambling, alcohol, pornography, weapons or tobacco; and
    
    
  • Companies that hold excessive debt even if the business activities are Shariah-compliant by nature.
    
    
  • Financial transactions must be transparent. Shariah forbids any form of deception (“gharar”) between parties.
    
    
• Transactions must be backed by tangible assets in the real economy. There should be no financial engineering. This means trading debt is prohibited, as is trading in financial derivatives.
  
  
• Investments must be approved by a supervisory board of Shariah scholars. Any financial institution offering Shariah-compliant products is required to have a Shariah board of at least three members in place. South African financial institutions adhere to the standards and codes of a global regulatory body, the Accounting and Auditing Organisation for Islamic Financial Institutions.

What types of investments are allowed?

Shariah permits investments in tangible assets, and investments earning returns from profits or rental or lease income. The asset classes fitting these criteria are equities and property (listed and physical), as long as the equities are shares in companies that are not in forbidden industries, such as those listed above.

In addition, Islamic finance has developed a type of “bond”, known as a sukuk. Bonds are debt instruments, whereas sukuks are backed by property or other cash-generating assets. Sukuks are also known as investment certificates.

Sukuk certificate holders collectively own the underlying assets and periodically receive profit generated by the assets, as opposed to bondholders, who receive predetermined interest at fixed intervals.

Although a sukuk may not offer as secure an income as a traditional bond, the investment risk and returns earned are similar to those of a bond.

What Shariah investments are available for individual investors in South Africa?

Islamic banks in South Africa and the major banks with Islamic banking divisions have a range of Shariah-compliant bank deposits for shorter-term savings.

But investors with longer time horizons should look for better returns from Shariah-compliant collective investment schemes (unit trust funds and exchange traded funds (ETFs)).

The first Shariah-compliant funds offered to retail investors in South Africa were equity funds. However, the widespread take-up of sukuks globally has meant asset managers have been able to diversify away from equities, leading to the emergence of multi-asset funds and income funds.

There are currently about 30 Shariah-compliant funds offered by South African asset managers. They comprise domestic equity funds, including an ETF tracking an index, the FTSE/JSE Shari’ah Top 40 Index (see below); domestic multi-asset funds; domestic income funds; a global multi-asset feeder fund; global equity feeder funds; and global property feeder funds.

Using these as underlying investments, some asset managers offer Shariah-compliant retirement funds for employers and their employees.

Shariah market indices

The JSE’s FTSE/JSE Shariah All Share Index was launched in 2007, and the FTSE/JSE Shariah Top 40 Index in 2008. The companies in the index are screened to ensure they comply with the Shariah principles by a Shariah board.

The Shariah All Share Index gives a good indication of what types of companies are Shariah compliant. According to research company FTSE Russell, of the about 350 listed companies on the JSE, 61 of them were in the Shariah index at the end of February 2024.

A third of these (21) are mining companies, 15 deal in consumer goods and nine are industrial companies.

This means that if you are investing in South African Shariah-compliant equity funds, it’s likely that a large portion of your investment will be in mining (resources) companies, which are subject to the cyclical fluctuations of the resources market.

Increases in the allocations unit trust and retirement funds can make to offshore markets has helped local Shariah compliant funds diversify away from this risk.

Shariah-compliance and returns

Shariah-compliant investments will deliver different returns to those investors in non-compliant investments enjoy. The universe of shares and other financial instruments the fund manager can choose is smaller.

It can be argued that the Shariah investments protect investors from the risks that come with investing in companies involved in activities such as producing tobacco products and those with a high exposure to debt. This can have long-term benefits.

However, at times in an economic cycle, this protection from risk may result in these investments underperforming investments that are not Shariah-compliant.