By Ron Robins

Sustainability issues and financial crises have spurred ethical and Shariah-compliant investing globally.

U.K. green & ethical funds increased to £9.5 Billion in 2009 from just £2.4 billion in 1999 reports EIRIS. In the U.S., ethical and socially responsible investing in all its varied forms grew significantly to $2.71 trillion in 2007 (the latest data available) from $1.2 trillion in 1997, says the Social Investment Forum. Presently, about one in every nine U.S. investment dollars has gone through some type of non-financial screen.

Sharia-compliant investments have taken off as well. “…investors globally hold more than $1.5 trillion in Sharia-compliant investments… [and] there are more than 500 funds globally that comply with Islamic principles, of which one-third of these funds were launched during the past four years, and the figure is projected to double in the coming five years… ” said Abdul Rahman Al Baker, executive director of financial institutions supervision at the Central Bank of Bahrain (CBB) at the Sixth World Conference of Islamic capital markets and investment funds on May 24.

“Due to its widening acceptance and its appeal as a means for ethical investment, the [Shariah-compliant finance] industry is expected to continue growing at twice the pace of its conventional counterparts ” stated Lim Hung Kiang Singapore′s Trade and Industry Minister speaking on June 14 at the World Islamic Banking Conference Asia Summit in Singapore. Shariah-compliant funds are now found in North America, Europe, Africa, the Middle East and Asia.

Many believe that Western ethical investing also has its roots in religious traditions. For instance, the Bible proffers ethical business conduct and the Quakers and Methodists of the 1700s offered strict rules concerning investments as well.

Most investors intuitively understand ethical investing: one applies personal values and ethics to investing. However, ethical investing has spawned, and shares, a close kinship to numerous other investment styles.

The ‘sister′ to ethical investing is socially responsible investing (SRI). In fact the terms ethical investing and SRI are frequently used interchangeably. SRI however, has been associated with left wing political views for a long time. Largely because of this association many in the industry have dropped the word ‘socially′ so that the term ‘responsible′ investing is now commonplace.

One new variant of ethical investing is ‘impact′ investing. This term relates to only using positive screens to find investments that have the most beneficial impact on society. Ethical-SRI funds usually use both positive and negative screens—the latter might screen out companies related to tobacco or defence etc.

Another type of ethical investing that is increasingly popular is sustainable or green investing. And for religious communities there are ‘faith-based′ funds, guided by the precepts of the associated group.

Shariah-compliant investing is also faith-based, rooted in the strictures of the Koran. Shariah-compliant investments must be approved by an independent Shariah supervisory board in accordance with religious Muslim principles.

However, in today′s complex world supervisory boards in different countries can vary in their interpretations of what is Shariah-compliant. Hence, many Islamic financial institutions are desirous of creating a pan-Arab/Muslim Shariah supervisory board. A Bloomberg report published on alrroya.com June 10 indicated that a supreme Shariah board could exist among Gulf Arab states by 2013.

Shariah-compliant investments prohibit investing in institutions that pay interest, or firms involved in gambling, speculation, pornography, tobacco, alcohol or pork products. They also generally shun financial institutions that have high leverage.

Both ethical and Shariah investing appear to have a bright long term future. However, it would not surprise me to see various western ethical funds take on some of the characteristics of Shariah-compliant funds. These might include stricter ethical practices, an external board governing ethical standards, and limiting investments in financial institutions with high leverage or risk.

Even the Vatican′s official newspaper, the Osservatore Romano, seems to promote such changes in western financial institutions and funds. Stating that (from Bloomberg on March 4, 2009), “the ethical principles on which Islamic finance is based may bring banks closer to their clients and to the true spirit which should mark every financial service.”

Because of their comparatively lower risk profile, Shariah-compliant funds may do better than ethical funds when there is an aversion to risk, and the converse might be true when investors believe they can go further out on the risk curve.

Globally, both ethical and Shariah-compliant funds are likely to continue growing faster than their ‘conventional′ counterparts. They share a commonality in that non-financial factors such as ethics and morality are instrumental in shaping investment decisions. Also, both arise from principally religious traditions.

Now, and most importantly, the awareness of climate change and continuing financial disorder are compelling regulatory authorities and investors everywhere to raise their environmental, social, and governance (ESG) standards—to the benefit of ethical and Shariah-compliant funds.

A future column will compare the performance of ethical and Shariah-compliant funds with conventionally oriented portfolios.

June 28, 2010

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