Exchange-Traded Funds (ETFs), an increasingly popular investment vehicle, are experiencing unprecedented growth. With projections showing that the ETF industry could double its assets to $15 trillion in the next five years, the significance of ETFs cannot be denied in the global financial landscape. This explosive growth also introduces intriguing opportunities for Islamic finance, an ethical and sustainable form of finance that aligns with Islamic law principles.
Understanding Islamic Finance and Halal ETFs
Islamic finance operates on ethical principles set out in Sharia law, including the prohibition of interest (riba), ambiguity (gharar), and activities considered harmful, such as gambling (maisir) and alcohol. Investments compliant with these principles are deemed “Halal” or permissible. Consequently, Halal
ETFs, being investment funds that comply with Islamic principles, offer a portfolio of assets that track an Islamic benchmark index. Moreover, the assets held within these ETFs are carefully selected to ensure they are not involved in any activities prohibited by Islam. Furthermore, an appointed committee takes on the responsibility of regularly reviewing the assets to guarantee strict adherence to Islamic principles.
Prominent examples of Halal ETFs include the Wahed FTSE USA Sharia ETF (HLAL) and the S&P 500 Sharia Industry Exclusions ETF (SPUS). These funds invest in large-cap and mid-cap stocks that comply with Islamic law, providing exposure to several equities, industries, or indices while remaining Sharia-compliant.
The Growth of Islamic Finance and the Opportunity in ETFs
Despite these challenges, there is a growing interest in Islamic finance, and Halal ETFs are a significant part of this trend. As ethical and sustainable investment options become increasingly sought after by investors, Islamic finance, with its inherent focus on such principles, stands well-positioned to capitalize on this demand.
The Opportunity for Islamic Finance in ETFs
Growing Interest in Ethical Investments
There’s an increasing global demand for ethical investments, including those that adhere to Islamic principles. The emergence of ESG (Environmental, Social, and Governance) and impact investing have only pushed ethical investments further into the spotlight. This trend presents a unique opportunity for Islamic finance to make its mark in the ETF market.
Increasing Awareness and Acceptance of Islamic Finance
Islamic finance once considered a niche, has gained global acceptance. Major financial markets, not just those in predominantly Muslim countries, now embrace Islamic finance. This increased awareness and acceptance create a clear opportunity for Islamic finance to expand into the ETF market.
Regulatory Support
Regulators worldwide are working to create an environment conducive to the growth of Islamic finance. Policies are being implemented to facilitate the introduction of new products, including Islamic ETFs.
Introduction of New Products
In August, Abu Dhabi-based Chimera Capital launched a new Shariah-compliant ETF offering exposure to the Turkish equity market — the ninth in its series, which already includes Islamic ETFs focusing on Kuwait, Saudi Arabia, the UAE, and the US.
However, it’s important to note that all ETFs and emerging markets don’t perform equally. As per TrackInsight data, broad emerging markets ETFs declined by about 17% in 2022, influenced by weaker performance in markets with significant exposure to China or Taiwan, given their turbulent economic year.
A notable anomaly is Malaysia, whose iShares MSCI Malaysia ETF dropped by -8.39% in 2022— despite its 8.9% GDP growth in the second quarter of 2022, powered by strong domestic demand and robust exports. This economic growth was not mirrored in the stock market, with Bursa Malaysia posting almost a 40% drop in net profit in the first half of 2022.
Challenges to Overcome
Although the opportunities are apparent, addressing certain challenges is essential for Islamic finance to make substantial inroads into the ETF market.
Lack of Standardization
There’s a lack of standardization in what constitutes an Islamic investment. Scholars and institutions may interpret Sharia differently, leading to inconsistencies that need to be clarified for potential investors. A standardized, globally accepted definition of an Islamic investment could go a long way in fostering growth.
Accessibility and Awareness
It is crucial to address the need for more standardization in defining what constitutes an Islamic investment. Since scholars and institutions may interpret Sharia differently, inconsistencies arise, creating a need for clarification to instill confidence in potential investors. Therefore, the establishment of a globally accepted, standardized definition of an Islamic investment holds immense potential in fostering growth and ensuring clarity in the field.
Despite growing acceptance, there’s still a need to raise awareness about Islamic finance and make these products more accessible to investors around the globe.
Efforts should aim to educate investors about the principles of Islamic finance and the potential benefits it can offer.
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