ETFs that invest according to Islamic principles have, for the most part, significantly outperformed their regular market benchmarks this year, owing primarily to sector tilts that are typical of Sharia (also known as “Shariah” or “Shari’a”) strategies.

Sector allocations have driven the majority of global Sharia indices’ outperformance in 2020.

According to research from S&P Dow Jones Indices, Sharia indices tend to overweight information technology stocks and avoid financials – a dynamic that has proven highly beneficial in the Covid-19 environment.

The information technology sector has led the market’s recovery since stocks bottomed out in March, while financial companies, which are nearly absent in Sharia indices due to the prohibition of investing in companies that deal in ‘Riba’ (interest), have notably lagged as record-low interest rates have squeezed profit margins.

Year-to-date, as of 30 September, the S&P Global BMI Shariah Index has returned 13.3%, while the traditional S&P Global 1200 has risen just 0.7%, resulting in outperformance for the Islamic approach of 12.6%.

Performance attribution analysis highlights that 7.6% of the global Sharia index’s outperformance came from sector allocations – the information technology sector accounted for 3.0% while financials added an additional 4.1%. The remaining 4.7% of outperformance not attributable to sector allocations was derived from stock selection differences within sectors.

Source: S&P Dow Jones Indices.

Sharia ETFs

Examining the performance of actual Sharia ETFs turns up similar results – with a few exceptions.

US-listed ETFs that invest according to Islamic principles include the $30m SP Funds S&P 500 Sharia Industry Exclusions ETF (SPUS US) and the $50m Wahed FTSE USA Shariah ETF (HLAL US), both of which target the US equity market.

The SP Funds S&P 500 Sharia Industry Exclusions ETF comes with an expense ratio of 0.49% and tracks the S&P 500 Shariah Industry Exclusions Index. The index screens the S&P 500 according to guidelines from the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI), removing firms conducting prohibited business activities as well as those with unfitting accounting metrics.

The index currently contains 221 constituents, weighted by float-adjusted market cap, and has a 39.0% exposure to the information technology sector (vs. 29.2% for the S&P 500). Year-to-date, the index has gained 13.7% compared to 3.3% for the S&P 500.

The Wahed FTSE USA Shariah ETF comes with an expense ratio of 0.50% and is linked to the FTSE USA Shariah Index which has risen 9.9% over the same period.

The index screens the constituents of the broad market FTSE USA Index according to similar business activity and financial ratio metrics. Islamic scrutiny is undertaken by Yasaar Research, FTSE Russell’s Shariah consultant. The index, also weighted by market capitalization, contains 200 constituents and has a 36.7% allocation to the technology sector.

In Europe, BlackRock offers a suite of three Sharia ETFs tracking MSCI Islamic Indices that cover large- and mid-cap stocks in global developed, US, and emerging markets universes.

Each MSCI Islamic Index similarly screens out companies based on business activities and financial ratios with the remaining constituents weighted by market capitalization. The methodology is relatively strict, however, resulting in indices that typically contain as little as one-sixth of the constituents present in the parent benchmarks.

Notably, the global and US Sharia ETFs have underperformed year-to-date as the funds’ methodology results in lower information technology exposure. The significant stock-specific risk may have also played a role in a lackluster showing.

The $150m iShares MSCI World Islamic UCITS ETF (ISWD LN) tracks the MSCI World Islamic Index and comes with an expense ratio of 0.60%. The index is down 2.8% compared to a 2.1% gain for the MSCI World Index. There is a 17.8% weight in information technology stocks (vs. 22.1%) and the top ten constituents account for a collective 28.0% (vs. 5.8%).

The $70m iShares MSCI USA Islamic UCITS ETF (ISUS LN) tracks the MSCI USA Islamic Index and comes with an expense ratio of 0.50%. The index is down 1.8% compared to a 6.8% gain for the MSCI USA Index. There is a 22.9% weight in information technology stocks (vs. 28.8%) and the top ten constituents account for over half (51.4%) of the index weight compared to 26.0% in the parent index.

The $60m iShares MSCI EM Islamic UCITS ETF (ISDE LN) has delivered notable outperformance, however. The fund costs 0.85% and tracks the MSCI Emerging Markets Islamic Index which has gained 7.2% year-to-date compared to a 0.9% loss for the MSCI Emerging Markets Index. Information technology stocks account for a 30.3% weight (vs. 18.5%).

Europe-based Islamic investors may also wish to consider the recently launched Almalia Sanlam Active Shariah Global Equity UCITS ETF (AMAL LN), the world’s first actively managed ETF to adhere to Sharia principles. The fund debuted on London Stock Exchange last month and has been brought to market through a partnership between Islamic finance house Almalia, investment manager Sanlam, and white-label ETF issuer HANetf. It comes with an expense ratio of 0.99%.