We all have different reasons to invest our hard-earned money. It might be for a short-term goal like the purchase of a car or house, or a long-term one such as funding our children’s education or ensuring a more comfortable retirement. Investing can take on a religious significance, too. For a growing Muslim audience, investments must not only be able to achieve their goals, but also be compliant with the Islamic law. At Franklin Templeton Investments, asset managers with expertise in Shariah-compliant strategies are located in the key Islamic finance centers of Singapore, Hong Kong, the United Arab Emirates and Malaysia. Alan Chua, EVP and Portfolio Manager with Templeton Global Equity Group based in Singapore, talks about the unique aspects of managing a Shariah-compliant equity portfolio and why profits and principles don’t have to be mutually exclusive.
Alan Chua, EVP and Portfolio Manager with Templeton Global Equity Group
The principles of Shariah investing dictate that to be considered acceptable, companies must pass a certain set of criteria. Among them, the balance sheet structure should contain neither too many liquid assets nor debt, and the company should not engage in “haram,” (forbidden) industries such as alcohol, tobacco, gambling as well as specific foods considered non “halal,” or unpure. Advisers who are considered experts in Islamic law are integral to the investment selection and review process. Our portfolios are independently reviewed and endorsed by the Amanie International Shariah Supervisory Board, highly regarded for its extensive Shariah and technical expertise. The Amanie Scholars provide initial approval on investment objectives and strategy, as well as ongoing supervisory and monitoring services to ensure continuous adherence to internationally accepted Shariah principles and standards.
Implementation of these standards can be subjective at times, as it is subject to the interpretation by different Shariah Boards, which is a challenge to us as portfolio managers. That can lead to a lack of homogenization of approach and can confuse potential investors.
For example, generally, a company that holds too many liquid assets may have Shariah restriction on eligibility. So one would think to eliminate the company. However, this is not always straightforward. It can depend upon the Shariah screening methodology applied by the fund adviser in the review process in which one calculates the company’s financial ratio. If a company classifies a large portion of its liquid assets as long-term assets, certain Shariah benchmarks will not include it as part of their liquid asset calculations. In addition, some benchmarks will use market capitalization as the denominator while others will use total assets – both of which could provide different results. Using market capitalization as the denominator is particularly difficult for value investors (like us) because as a stock gets cheaper and hence provides more long-term value, it could suddenly become ineligible as the market capitalization falls relative to the liquid assets or debt.
Stocks that were compliant at one time but then later deemed non-compliant must be disposed of, but once again it’s all about details. For example, the frequency at which the company pays its dividends (once a year, semi-annually or annually) could make a difference to eligibility. Depending on the Shariah screening methodology, a company that accumulates large amounts of cash throughout the year before paying it out in the form of dividends runs the risk of becoming non-compliant. Once it pays the dividend, it may become compliant and hence an eligible investment once again. The grace period given to dispose a stock (once it becomes non-compliant) is also different from one benchmark or adviser to another. In the dividend example, if the grace period to sell non-compliant stocks is short you may be forced to sell it before it pays the dividend but conversely if your grace period is long, the stock could remain compliant by paying the dividend and reducing cash on the balance sheet.
Such are the challenges of Shariah investing! But despite the constraints, we are able to find plenty of potential opportunities.
In managing our Shariah portfolios, we leverage the same investment team and research process in place in the Templeton Global Equity Group at large. So the Muslim investor is essentially getting a subset of our broader portfolio, but one which is compatible with specific Shariah principles. Our team overall is finding potential opportunities in the healthcare, energy, and telecommunications sectors. European financials represent a sector our Shariah portfolios can’t invest in, but we’ve been finding a lot of value over the past year there in our other portfolios.
By country, Malaysia represents one of the biggest markets right now for Shariah investing, and is growing because of its advanced national pension scheme. There is a mandatory monthly contribution into the national pension fund that grows with population and income levels. Other big centers include some of the Gulf States in the Middle East like Dubai and Abu Dhabi. I think the natural interest in Shariah investing is likely to be confined to Muslim nations, but it would not be surprising to find other countries also interested in offering an Islamic investment vehicle as there is a large and growing Muslim diaspora globally. So our potential investment opportunities could likewise continue to expand, and we think it’s an exciting time to be an investor in this growing space.
Want to learn more about the fixed income side of the equation? Read about Islamic bonds (sukuk) in our Beyond Bulls & Bears post, “Is Islamic Debt a Salve for the Risk-Averse?”
WHAT ARE THE RISKS?
All investments involve risks, including possible loss of principal. The value of investments can go down as well as up, and investors may not get back the full amount invested. Stock prices fluctuate, sometimes rapidly and dramatically, due to factors affecting individual companies, particular industries or sectors, or general market conditions.
Special risks are associated with foreign investing, including currency fluctuations, economic instability and political developments. Investments in developing markets involve heightened risks related to the same factors, in addition to those associated with their relatively small size, lesser liquidity and lack of established legal, political, business and social frameworks to support securities markets. Such investments could experience significant price volatility in any given year.