Islamic finance is set for more growth as the widespread socioeconomic development in the Middle East, North Africa and South Asia regions is expected to continue. The growth is driven by multiple factors such as:
• A growing Muslim population standing at around 1.7 billion, out of which 50 million in Europe are looking at investment products catered to their needs;
• The search for ethical investments by Muslim and non-Muslim investors;
• A growing number of Islamic and conventional financial institutions entering the space; and
• Islamic asset management can feed into an Islamic wealth management industry serving a growing Muslim demographic forecast by Pew Research to reach over 26% of the global population by 2030.
Review of 2020
The latter part of 2020 has seen global equity markets continue to stabilize and maintain their gains off the lows of late March. The size of the recovery has taken many investors by surprise as economic activity is still subdued and a full recovery to pre-COVID-19 levels looks set to take a number of years. With interest rates at near zero levels in most developed markets we have seen, the market has been prepared to look through much of the near-term noise.
In addition, eyes are now on the US presidential election as it comes to its conclusion and the market digests what a democratic government means for policies in the future. We believe that relationships between the US and the wider Islamic global community will be enhanced under a Joe Biden presidency. Biden is on record for saying he will protect Muslim-American constitutional and civil rights, honor the diversity of Muslim-American communities and make communities safer as a consequence.
Market recovery peaked at the beginning of September after which it suffered a small pullback before stabilizing again. The pullback was particularly focused on some of this year’s most stellar performers on the NASDAQ exchange. The focus now seems to be on the severity of the recent increase in cases in Europe and the UK as these economies see the effects of their prior reopening.
Despite a return to lockdown in several western economies however, there are signs the economy is recovering. Take a step back – the MSCI World Index’s returns this year have been dominated by big tech stocks whose returns have powered upward seemingly unchecked for months, with more complacent market participants finding themselves caught up in a herd mentality. The result? Portfolios filled with these “COVID-safe” stocks which are either largely unaffected by – or even benefit from – lockdown measures, many of these trading at valuations in some cases reaching eye watering levels.
Many of these big tech stocks, whose moves have resulted in a world index which has a larger weighting in Apple and Microsoft than the whole of the UK combined, are not considered compliant by many Islamic screening measures and are often excluded from these portfolios, and are indeed excluded from many of the recognized Shariah compliant indices.
And whilst this year this phenomenon has caused a dispersion in returns between those indices that exclude these stocks, and those that do not, looking at the performance of the UK stock market in isolation, the returns of the Shariah compliant UK stocks versus non-compliant are very similar – both returning around -10% in US dollar year-to-date and vastly underperforming the broader world market.
For those investors with a quality mindset, a Shariah compliant portfolio can be well aligned; a key screening measure of course being the exclusion of companies with poor balance sheet strength in terms of high debt levels. With the likes of HSBC and Lloyds weighing heavily on the UK market this year, facing dramatic drawdowns, along with telecommunications stocks such as BT and Vodafone whose resilience in the face of this adversity was simply not up to task, these stocks would have been avoided in a Shariah compliant UK stock portfolio.
However, this may well have been offset by the inclusion of energy companies such as BP which also have fallen under heavy fire but are nonetheless considered compliant. With this information in mind, what does this illustrate? Perhaps more than anything, that careful stock selection, be it Shariah compliant or not, can have a significant impact on returns. An actively managed portfolio that can avoid these parts of the market that offer less resilience in times of stress, and take advantage of opportunities when they arise, can add value in the long term.
Now fast forward – the purchasing managers’ index, which measures economic trends in manufacturing, has risen from 37 in April to 53 in September – the highest it has been for over two years. Factories are running, and inventory levels are being restocked. Early November heralded a significant change in tone for markets. After months of outperformance by tech stocks such as Amazon, Apple and Microsoft, the tides changed and many investors found themselves wrong-footed by the switch in sentiment.
With Pfizer’s vaccine news providing a glimmer of hope for a return to normality, cyclical stocks in industries such as travel, banking and hospitality staged a significant rally. On the day of Pfizer’s announcement, markets rallied strongly with the UK FTSE 100 index up nearly 5%. With the UK back in lockdown, positive vaccine news had a much more material impact on the UK market compared to many other parts of the world.
Cyclical companies in particular benefited from the news after weeks of being overlooked in favor of tech names, which fell subsequent to the news. As such, this has the potential to be the start of a regime change as investment managers recognize that omitting these names from portfolios leaves scope for material underperformance. Whilst Monday , the 9th November 2020, was a highly unusual day in markets, positive vaccine-related updates are likely to provide repeats in this pattern and could provide the tailwind to value stocks that they have so desperately needed.
Looking back at 2020, we see that within the Shariah compliant global equity investors, they are looking more and more for value-added investment vehicles that serve a specific purpose, which offer value for money too. The relentless rise of exchange-traded funds (ETFs) has led to an explosion of ETFs across the globe but with an unfocused approach and often at higher costs than at first glance. We believe the need for active management in the global equity industry is very important.
Preview of 2021
Investors are focusing more on how they can add value in two ways. Taking active risk in their global equity portfolios with the aim of adding long-term outperformance versus an index. A Shariah compliant investment must still be a good investment, and that global equity investors keen on following a strictly Shariah compliant global equity approach might well be very keen for an active vs a mere passive approach which used to be the norm.
A focus on high quality companies with a strong valuation overlay can add significant value to investors over time. The screening process for the universe of Shariah compliant names is overseen by a Shariah panel which reviews the proposed equity securities to ascertain the ongoing compliance of the ETF’s operations with the principles of Shariah investment. This panel consists of Shariah scholars with expertise in Islamic investment which is critical for Shariah compliant investors.
Global equity investors in the UK are also increasingly focused on environmental, social and governance considerations when they invest with third parties. Although Shariah and sustainable approaches to investing have developed independently, both look to bias investment in more sustainable outcomes and can be aligned in many ways. Many sectors that are excluded under Shariah law also score poorly on sustainability criteria.
Conclusion
Few could have predicted the extent of disruption the coronavirus would have on the global economy when news first broke concerning the outbreak in China in late 2019. March 2020 witnessed one of the sharpest falls in asset prices in history due to the continued escalation of the coronavirus pandemic around the globe, and its now irrefutable broad-based negative impact on company earnings worldwide.
Given the continued uncertainty surrounding COVID-19, it would have been wrong to assume a sharp recovery in equity markets after such a deep shock back in March. Yet, here we are. With equity returns now higher than they were for most of 2019, the recovery has been extraordinary.
Clearly, the global economy is not out of the woods yet, and while we do not expect markets to revisit the lows of March, there is a lot for investors to come to terms with. There may well be aftershocks yet to come, but we see these as buying opportunities, and our focus going forward will be on careful asset allocation and stock picking.
Pieter Fourie is the head of global equities at Sanlam Investments UK. He can be contacted at [email protected].