Investment Alchemy series: Understanding faith-based or Sharia-compliant investing

Connie Queline

Investment Alchemy series: Understanding faith-based or Sharia-compliant investing

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SIMON BROWN: I’m chatting with Maahir Jakoet. He is portfolio manager at Old Mutual Investment Group. Maahir, I appreciate the time today. The screening of shares – we are talking here around faith-based sort of Sharia-compliant investing. The screening of shares with some hard and soft exclusions is a large part of that investment process. Tell us what that process is and about some of those exclusions.

MAAHIR JAKOET: Thanks, Simon. Yes. This is the starting point to get to a universe as a Sharia-compliant portfolio manager. And once we get this universe, that is when we apply our investment philosophy on top of that.

But I would rephrase the ‘hard’ and ‘soft’ – those words are – rather say ‘qualitative’ and ‘quantitative’ because how it actually works is that there’s a body of scholars on our Sharia board, together with a compliance department that then screens the entire universe. Now I’m talking local and global, so local on the JSE, global on the S&P.

The qualitative factors relate to the core activities of the business. For example, Vodacom is a telecommunications business at its core, while AB InBev, previously SAB, is a business which is classified as consumer staples. However, at its core it sells alcohol, which is non-permissible in Islam.

Another sector that is excluded from our universe is the banking sector, as charging and receiving interest is also not permissible. So that’s the first screen.

And then there’s the quantitative screen, which is actually mathematical calculations from the annual financial statements. These are ratio-based calculations. An example of a ratio is that non-permissible income divided by revenue cannot be more than 5%. So non-permissible income is that a business is fine at its core, but it’s got an interest-based investment on the balance sheet, and that is the non-permissible income over the revenue that it generates.

Another example of a ratio is the total debt ratio, which is total debt divided by the market cap or total assets that cannot be more than 30%. There are obviously reasons for that, but that’s how the second screen on the quantitative side works.

Then we end up with the universe and we apply our investment philosophy on top of that.

SIMON BROWN: Gotcha. Any examples? I’m thinking – let’s take a hotel group for example. The majority of their income is going to come from room nights, but they’ve probably got a bar, they’re selling some alcohol. But if those alcohol sales are just a percentage or two of revenue, that’s fine.

MAAHIR JAKOET: Yes. And we’ve got a separate process outside of this, which is called a non-permissible income calculation, where we actually strip that out on a daily basis so that our investors get what we call a ‘purified’ investment when they go in and when they exit the investment.

SIMON BROWN: If you’re removing interest-bearing assets –there are obviously a fair bunch excluded, but interest-bearing in particular, because we’ve seen the banking sector over the last couple of years, particularly with the [current] interest rate environment – how has this sort of impacted performance in having that exclusion?

MAAHIR JAKOET: That’s an excellent question. I think it’s important to understand how banks make money through what we call a net-interest margin, which is just simply borrow lower and lending out higher. However, I think that other factors play a role like loan demand and other economic conditions.

But what I’m trying to get at here is that yes, in a rising rate cycle banks tend to do well until consumers and businesses feel the pinch. So obviously there’s that positive uptick until a certain point. But more to your question, I think when rates are higher we can invest in Islamic fixed-income instruments – which is called Sukuk – on the local side.

And then, when a sector is excluded, [there are] other sectors such as healthcare – which is uncorrelated to interest rates – utilities as well as energy. So there is space to move and have that decision to just move around within the sectors, even if a sector like financials is excluded.

SIMON BROWN: I take your point. These are markets, there’s always somewhere to be making money. There’s an argument out there that says that faith-based investing in a sense is inherently ESG – environmental, social and governance [focused]. Are there differences or fairly significant crossovers in terms of using a broader societal objective?

MAAHIR JAKOET: Yes,. Absolutely. So I think on the ESG side there’s a big focus on fossil fuels and controversy monitoring, but on the ESG side we also exclude alcohol, adult entertainment, gambling, tobacco and weapons. Now that falls squarely as a crossover within a faith-based or Sharia-compliant fund.

So I think that the differences there would probably of course be the financial sector, entertainment, as you mentioned – but also from the quantitative rules, the excessively leveraged companies on the Sharia side, which end up at a starting point with quite a quality-based universe.

So those crossovers are alcohol, adult entertainment, gambling, tobacco and weapons, and then there are some nuances on either side. But you would always expect a faith-based or Sharia-compliant portfolio to be highly ESG-aligned as well.

SIMON BROWN: I want to touch back to returns, because investors invest for return – that’s at the heart of it.

Let’s talk about the performance of faith-based [investments]. You’ve got the Old Mutual Global Islamic Equity Fund. How are returns doing? A lot of people will say, ‘As soon as I sort of reduce my market I’m going to suffer in returns’. Now, you pointed out a moment ago that in terms of banking, there are others that could do perfectly well. Do the returns stack up?

MAAHIR JAKOET: Absolutely, they do. Actually. If we look at the 2023 year, the MSCI World, which is a developed-market index, did about 24.5%. And then the MSCI ACWI, which is the All Country World Index, did 22.8%, so slightly lower. Our portfolio delivered north of 31%.

We saw similar good performance numbers on the local side. But because you specifically honed in on the global, the portfolio did outperform its conventional benchmarks. So what does that mean?

It means that we can debunk the myth where people assume that in a smaller universe – where we are constrained and cannot hold financials and other sectors – we are going to do worse, because we’ve proven that actually in this universe, call it what you may, with our hands tied behind our backs, we’ve delivered.

So that debunks the myth in terms of investing in faith-based or ESG.

I think that the narrative gets skewed when we talk about ESG. If investors are truly long-term investors, I do believe that those better ESG companies should do better; and you invest in those types of portfolios because it’s really the right thing to do, rather than to have a performance narrative over the short term.

But what this does do, is that it gives conventional or multi-asset investors the opportunity to say: ‘Hey, this guy’s got a different performance signature. I’ve got all this conventional stuff. If I add it together, actually, that would help me diversify my holistic portfolio, which is really the education and the narrative that needs to be put out there.’

SIMON BROWN: That’s a great point. This is around sort of that diversification in a portfolio. If I’ve got 10 fund managers and they’re all kind of chasing the same universe, I’m not going to get the same returns but there’s no sort of differential between them, really. Here there is.

And you mentioned the universe. It is a smaller universe, but when we are looking globally, it’s still frankly a very large universe. You’ve removed a lot of equity from it, but the global market is huge.

MAAHIR JAKOET: Absolutely. So, to give you the exact numbers there, the S&P Islamic Index is actually the largest Islamic index. So at a starting point we use that index, and that holds about 710 shares, and we end up having to build a lovely portfolio with about 80 stocks from a universe where about 387 are allowed.

So you’re absolutely correct. I think it’s slightly hard on the local side, but on the global side from almost 400 stocks you can build a very good portfolio to meet client needs.

SIMON BROWN: And, as you say, a different portfolio, a different methodology which can give you that alpha – which is ultimately what the investors are seeking.

Let’s change track a bit and look more broadly. We’ve got an action-packed year, elections happening in the world over, debates around soft versus hard landings in the US. Expectations are that interest rates will start coming down. What sort of events and factors are you anticipating will impact a global universe portfolio most?

MAAHIR JAKOET: I think I’m going to answer this question in various parts.

I think that, firstly, a lot of people want the crystal-ball answer and actually we don’t know. So a strategy is to build a shock-proof portfolio.

Now in our philosophy we’ve got quality at the core, but the businesses must have the ability to grow, and they must be priced attractively. So if you look at the second elements of being able to grow, we need the growth to come through. And then we also want that valuation.

So we want to buy at-priced assets. And I think that’s the strategy we are going for because the Fed – are they going to hike and how much, when? These are the types of questions that we definitely ask ourselves. There hasn’t been a time in history where rates have been this high, this long, and something didn’t break.

So again, this week the labour data came out very hot. Non-farm payrolls came in at 335k versus the estimated number of 185k. Now that’s a blowout number.

But in summary, with all of this data that we are looking at, the US consumer seems to be doing just fine.

So with that being said and rate cuts coming further down the line, we could actually very well see a soft landing.

I think the other big thing in the market is China. This week CPI data came out almost negative – 1%, 0.8%. That’s the weakest since the global financial crisis. So I don’t see a quick or easy fix here to the housing market in China as well as the monetary stimulus.

The government have a few levers at their disposal, but I don’t know how they’re going to address this depressed consumer sentiment, really.

So we’ll go with a strategy of the barbell approach, where you have value and growth on either side but quality at the core, because I think over the long term that’ll benefit our clients and our investors.

SIMON BROWN: I take that. I like that 100%. If we go back four years, you say you don’t know, [but] four years ago – well, what have we seen since then?

The first pandemic in a hundred years, the highest inflation rate in developed markets in 40 years, as you say, and incredibly high rates for an extended duration of time. No one was predicting any one of those, never mind all three of them.

As long as you’ve got those quality businesses with potential for growth, that’s what’s going to sort of manage you through when the curve balls come – and they’re going to come. Perhaps the only certainty is the uncertainty.

MAAHIR JAKOET: Absolutely. I always say if somebody else is giving you 20% positive, and I’m giving you 18%, the phones don’t ring in the office, I can tell you that. But if the market’s down 20%, I need to make sure that I deliver at least minus 10% to be better than the market on the downside. I think that’s what the equality philosophy really helps with, and that’s our strategy.

SIMON BROWN: Yes, it’s not about trying to predict the future at all. We will leave it there. Maahir Jakoet, portfolio manager at Old Mutual, I appreciate the time.

This podcast series, Investment Alchemy, is brought to you by the Old Mutual Investment Group. In relentless pursuit of investment excellence.

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