Shariah-based investments have grown considerably in recent decades, as the Islamic investment community demands increasingly sophisticated investment solutions that are in accordance with Islamic law. As a result, the need for high-quality, transparent Shariah compliant benchmarks has developed. Today, Islamic indices serve an essential role in Islamic finance; these unique indices identify the universe of securities available for investment and define the way investors measure the Islamic financial markets. SABRINA SALEMI puts Islamic indices under the microscope.
Although Islamic equity indices may be limited in coverage due to rules-based screening processes, particularly in certain sectors such as financials, they maintain a high correlation and have comparable risk/return characteristics to conventional underlying indices. Representative of each market, each index provides investors with Shariah compliant versions of various major benchmarks. For example, the S&P 500 Shariah Index is a subset of the widely recognized S&P 500 Index and includes only Shariah compliant constituents of the S&P 500 Index.
Review of 2015
While most of the global benchmark indices were in the red over the last year, the Shariah subsets of these indices generally mitigated losses and outperformed conventional indices. The S&P Global BMI Shariah and the Dow Jones Islamic Market World – two major global Shariah compliant benchmarks – each declined 8.8% in the third quarter, but outperformed their conventional counterparts by 130bps as greater exposure to the US boosted performance. This has also been the trend for the past 12 months, as the two indices outperformed their conventional benchmarks by 140bps and 120bps respectively.
All major regional equity markets finished the quarter in the red in US dollar terms. However, the 6.7% decline experienced by the S&P 500 Shariah and the S&P Europe BMI Shariah indices fared well relative to the double-digit losses experienced in Asia and emerging markets. Furthermore, all of these regional Shariah indices outperformed their respective benchmark index on a quarter-to-date basis.
Other noteworthy movements over the past year have stemmed from plunging oil prices, which have had a significant impact on the industry performance and weighed on the MENA equity market. Over the past 12 months, the S&P Pan Arab Composite Shariah lost 32.7%, while GGC countries were hit even harder as the S&P GCC Composite Shariah Index dropped 33%.
Preview of 2016
While Islamic finance and Shariah-based investments have experienced healthy and encouraging growth over the past decade, the industry’s development can be significantly improved by broadening the base of issuers and investors, expanding geographic reach, and building scale. Sustaining the rapid growth achieved will necessitate greater breadth and diversity in products and solutions offered. As global markets continue to develop infrastructure that supports the Islamic finance industry, Shariah-based investments will also continue to develop and expand through new international opportunities.
In addition to geographic and product expansion requirements, the Islamic finance industry will need to raise more investor awareness and confidence in order to successfully progress. Many investors are under the impression that Shariah products do not provide similar risk/return profiles as conventional products, which is not the case. With time, it will also become increasingly important for the Islamic finance industry to harmonize and better define regulations with respect to Shariah laws, so all stakeholders can invest with confidence and greater transparency.
As an index provider, we believe that indices have a key role to play in accelerating this trend. The S&P Shariah Indices and Dow Jones Islamic Market Indices, for instance, adopt investment criteria defined by Islamic law and represent the most extensive and comprehensive suite of indices available to regional and global Shariah investors. The series includes developed, emerging and frontier benchmarks, regional and country-level investable indices in addition to indices in specific strategies and sectors. Furthermore, Sukuk indices have also been developed at a faster pace to meet the demand for Shariah compliant fixed income solutions. The availability of these financial benchmarks benefits investors globally with a deeper understanding of and greater accessibility to the Islamic finance market.
For investors who wish to diversify their portfolio while adhering to prescribed Shariah law, Islamic indices provide market participants with a comprehensive set of benchmarks. As the industry evolves, index providers continue to meet the demands of a growing market by introducing innovative indices catered to Shariah compliant investors. And in the latest phase of development, the introduction of smart beta and mixed asset class strategies specialized for Shariah compliant investors denotes the promising growth of the Islamic finance market.