Can retail Islamic funds gain traction as SRI funds?

A report published by Thompson Reuters in 2014 found that a key challenge faced by the Islamic retail asset management industry is scalability. The report highlighted three solutions to reach the required scale, one of them being to position Islamic funds as socially responsible investment (SRI) funds.

The conventional funds management industry has one sole motivation — to maximize risk-adjusted returns. While this approach may have been acceptable and agreeable to all investors in past years, a growing number of investors are now seeking investments that agree with their conscience, moral, ethical and/or religious values.

The natural overlap between both SRI and Islamic investments is that they seek businesses which are not detrimental to humanity and which comply with mandates of ethical or religious principles. Both apply negative screens to filter investments, and their common list of forbidden sectors includes alcohol, gambling, tobacco, adult entertainment, and weapons — businesses that are often deemed harmful to humanity and society. However, it must be noted that Shariah filtering principles apply quantitative financial screens, in addition to the ethical business screens, which further shrinks the investable universe.

Recent studies have also proven a common philosophy to be a misnomer. For decades, many have held the view that investments which are socially responsible and/or Islamically compliant lack diversification and underperform. However, an analysis of SRI funds globally indicates that the performance trend is rather unexpected. Despite having a lower base at inception, SRI funds have swiftly reached the same performance levels of their conventional counterparts and at times outperformed them, proving that investing ethically or Islamically does not necessarily result in underperformance.

It goes without saying that both SRI and Islamic investments face similar challenges as well. They have an added layer of costs to bear in terms of filtering, compliance, and certification. Both investment methodologies are not yet standardized across their respective segments, and they are both driven by institutional investors which means that it may be some time before retail asset managers share significantly in this growth.

From a scalability perspective, positioning Shariah compliant funds as SRI funds would enable retail asset managers to reach a broader range of investors and enhance the brand of Shariah compliant funds. Amalgamation of Shariah compliant filters and SRI principles would reduce the overall risk profile of the funds.