Much of the euphoric 15% rally seen in the summer months of 2022 was down to a large sell-off in the price of oil which feeds directly into petrol pump prices, which in turn feeds directly into lower inflation numbers. This move lower in oil and pump prices gave investors the confidence that with inflation consistently coming down there would be less need for central banks to raise interest rates to the extent that a recession would ensue.
Review of 2022
This ultimately proved short-lived, and another sell-off set in at the back end of September as inflation numbers failed to come down in the magnitude that the summer’s positivity had led investors to expect. Shariah was not immune from the sell-off, but the high-quality nature of the sector helped to deliver good levels of protection for investors.
For investors in Islamic investment strategies, it is worth visiting this defensive point in more detail because this year will likely prove a critical litmus test for Shariah investing. In the volatility we have seen in 2022, the Shariah market continues to be as dependable in a bear market as it does in a bull market.
Why? Shariah investing over the bull market of the last few years has kept pace with, and often exceeded, the performance of many of the world’s best non-Shariah ‘growth’ funds. Predominantly what makes a good Shariah compliant investment has focused on good companies with well-run balance sheets, diverse boards, robust earnings margins and importantly, very attractive future growth projections.
It is no surprise then that many of the stocks which have made their way into Shariah funds have also found their way into high-quality ESG and mainstream growth funds, which has been one of the best places to be invested over the last five years. From a purist angle, this outperformance in up markets demonstrates Shariah law guiding Muslim investors into the right companies, and the market has agreed with and rewarded them for this dedication to religious-based investing.
Fast forward to 2022 and most investors will know that the hallmark of this bear market has been investors selling those same growth companies on fears that raising interest rates and a recession would obliterate the attractive future growth prospects, and in the main this has been exactly what has happened.
Yes, we see Shariah strategies being insulated from a lot of the pain. Take the likes of Fundsmith’s celebrated global equity fund which is down over 26% this year alone against iShares World Islamic ETF which is down 14% in dollar terms.
From a professional investor’s perspective, Shariah investing delivering 12% outperformance on Fundsmith in just 10 months is a significant point to note. Considering this outperformance is against one of if not the most well-known and widely held global funds, it just shows how effective the Shariah market has become in outperforming its mainstream growth competitors in down markets.
These relative outperformance numbers become more extreme when one takes another high-profile growth fund, the ARC Innovation ETF (a celebrated fund with deep ties to religious-based investing), falling 60% in 2022. Again, Shariah markets are, on average, down less than half of that.
Broadly speaking, the same observation holds true when looking at the whole market, with the iShares MSCI World Islamic Index outperforming the FTSE All World Index by nearly 40% this year. Again, one can look to Shariah law guiding investors to owning high-quality companies which hold up well under pressure.
Individual fund selection remains risky, however, with different Shariah funds providing different offensive and defensive capabilities which need to be blended to give an enhanced level of protection. This is where Shariah managed portfolio service (MPS) solutions, such as TAM’s, have come into their own in this downturn.
Mainstream industry benchmarks such as the IA Mixed Investment Sector and ARC Private Client Indices are down 12% and 13% respectively this year, whereas Shariah MPS portfolios are down just 4% over the same period. This Shariah model portfolio was up 40% in the five years to the end of 2021, when those same industry benchmarks were only up 26% and 27% respectively.
Right now, the only industry to boast outperformance in both up and down markets largely remains the hedge fund industry (which is struggling this year), and for those hedge funds which are not, clients can expect to pay 2% upfront and 20% per year in fees, which makes their strategies unaffordable, unsuitable and unattainable for many average investors.
Preview of 2023
Looking forward, the global economy appears to be slowing down, but inflation is not. Markets are seemingly torn between the fear that central banks are going to raise rates into recession territory while showing positivity on the belief that supply side inflation drivers are going to drop off enough to slow inflation to the point where central banks stop raising rates and pull off the elusive ‘soft landing’.
This positivity and negativity oscillating around economic indicators such as unemployment numbers, wage inflation, everyday goods inflation, consumer sentiment, house prices and interest rates have the potential to keep markets volatile with elevated risks.
It is worth stressing that volatility means markets go up and down, so if the news flow from the aforementioned indicators surprises on the upside and indicates inflation slowing faster than many are expecting, then we can reasonably expect a continuation of the rally we are currently seeing. Precious metals (gold and silver) continue to remain a fantastic hedging option against dollar weakness the likes of which we saw in September.
While there is an opportunity in this uncertain market to start to invest cash now, we envisage some more challenging months ahead and thus remain very much in defensive investments which are suited to protecting investors in times of stock market volatility.
Conclusion
The Shariah market remains underdeveloped and underfunded, and the challenge remains to widen the range of funds available for Shariah investors. However, Shariah’s status as a true safe haven for investors could very well be the silver lining of this market, a defining point in the history of this fascinating sector, and something to get excited about when this market gets back into rally mode.
Brian Adams is the director of Islamic wealth management at Merlyn Wealth Management. He can be contacted at [email protected].