DDAV Analytics’ Analyzing Sharia Compliant Investments

May 6, 2009 - PRLog -- Of late there has been a lot of focus on investing in Sharia compliant funds. Especially in these times of economic turmoil and corporate fraud, investors are looking to invest in companies that are not finance related and follow safe business practices as a bet towards less risky investments. World-wide, Hedge Funds and Asset Managers are launching increasing number of Sharia compliant funds aimed at not only the Muslim world, but Europe, US and Asia as well.

There have been several discussions regarding the basic principles of such investments for some time now. Sharia guidelines prohibit funds to invest in companies that are related to businesses of interest-based finance including insurance, alcohol, tobacco, gambling, pornography, music, entertainment, illegal arms and ammunition, pork, non-Muslim fabrics and designs and hospitality where segregation of sexes is not practiced.

Although it is easy to identify the above issues, it is tricky to identify investible companies and businesses that adhere to these principles. This is due to several intricacies involved in the process of identification. One of the key areas of concern is that companies today operate in diverse business segments across different geographies and cultures. Local customs and laws are different and have different levels of reporting. Local subsidiaries of global companies do not necessarily capture the data required to classify companies as Haram or Halal if it is not required locally. In cases where it is captured, disclosure norms do not demand that such detailed data be made public. If inquiries are made, most companies do not divulge such level of data due to competitive reasons.

Another key challenge is analyzing the value chain. Sharia law prohibits investment in companies that consume, produce or distribute prohibited items if the value of all such transactions exceeds 5% of aggregate revenues. What is stipulated additionally is that not more than 5% of the aggregate revenue must be from sales to organizations that use halal products for haram use. For example, a truck manufacturing company is, in itself, an eligible investee. However, the complication arises if the trucks sold by the company are used by the purchaser to transport non-compliant goods such as liquor, cigarettes or DVD’s, and to ascertain whether more than 5% of sales are to such customers. By the very nature of the transport industry, such data is typically not readily available and thus, if one takes a conservative approach, all logistics companies are suspect.

Also, Sharia scholars are of differing opinions on how to treat haram items that are used in the manufacturing process but not necessarily found in the end product. For example, if alcohol is used to clean the machinery used to manufacture halal products; does it exclude the company from being eligible? Also, there is still lack of clarity about alcohol in the use of medicines such as cough syrups and life saving drugs. Some scholars suggest that if a drug contains less than 2% alcohol by volume, then all revenue from that drug is halal, whereas if the alcohol content is greater than 2%, the total sales from such products must not exceed 5% of the total revenue.

Sharia law prohibits the use of arms and ammunition for any purpose other than that for the lawful defense of a country, including internal policing. This is applicable only if the government of the country is a lawful government. Besides the normal questions this throws up in politically sensitive parts of the world, the main issue is disclosure by companies. No company discloses the complete list of its client organizations and whether any of them are non-governmental organizations.

In order to address some of the above issues, and to allow investors to identify investible stocks, several financial advisors have built various Sharia indices which are published regularly. Independent research suggests, however, that most of these indices are not accurate as the basic research done to include or exclude stocks from the indices is not in-depth enough to identify potential issues based on all the above mentioned factors.

In spite of the above challenges, Sharia compliant investments is an idea growing in popularity, be it due to increasing investible surpluses in the Sharia world or because of investors’ disgust towards the blunders of larger-than-life asset managers.

Data providers, in partnership with certain asset managers, have attempted to build automated systems to identify potential investee companies. However since the above-mentioned guidelines are subject to different interpretations, the probability that anyone can come up with a single framework which is applicable across the board is unlikely. Even if such a framework can be built, the probability of data being available in an automated manner is pretty remote and a significant amount of thoughtful manual research is needed. Due to these complexities, efforts to build automated systems have had limited success.  

Some financial researchers have spent a considerable amount of time and effort to resolve the above issues.  And although not fool-proof, have been able to devise strategies to practically identify investible companies that pass muster with the Sharia advisors. It is hard work, but well worth the effort.

Dawnay Day AV Analytics (DDAVA) has significant experience in analyzing companies for Sharia compliance. In the past twelve months, DDAVA has analyzed over 5000 companies across the world in this respect.

If you would like to know more about our capabilities in this area, or would like to take advantage of our expertise, please contact at john.panga@ddavanalytics.com .

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Dawnay Day AV Analytics is a financial research company providing research and analytical services to clients based in the US, Europe and Asia. Services range from simple data compilation to financial research, analysis and modeling.