Halal Investing vs. Ethical Investing

Surianom Miskam

 

Halal investing is sometimes referred to as Shariah investing or Shariah-compliant investing while ethical investing is also known as socially responsible investing. Growth in both halal and ethical investing is mainly contributed by the fact that the corporate world is becoming more sensitive towards shareholders’ increasing social awareness and contribution to real economic activities.

 

Halal Investing

Halal investing is based on religious belief which means that all investments must comply with Shariah principles. Halal investing must, therefore, abide by Shariah principles, which are to be free from prohibited elements that include riba (interest), maysir (gambling) and gharar (uncertainty). Riba or interest is expressly prohibited in the Quran. Basically, riba is the excess money paid by the borrower to the lender over and above the principal for the use of lender’s money over a certain period of time. Thus, financial products bearing the element of riba such as interest-bearing deposits, bonds, private debt securities and money market instruments are considered non-permissible (haram).

Maysir which literally means a way of obtaining something easily and deriving unearned profit, are driven by pure chance. As a game of chance, gambling often makes people take high risk and behave irrationally in order to win big. Extreme risk-taking behaviour without the knowledge and value-adding elements is prohibited in Islam in view of the outcome with the possibility of losing money. Gharar basically refers to uncertainty in contractual terms that might lead to exploitation and deceiving people which could lead to disputes and manipulation of contract. In addition to the three prohibited elements, halal investing is also based on the principle that Islam prohibits any dealings with non-permissible (haram) activities such as wine, alcohol, adultery, gambling, tobacco, conventional banking and insurance, and pork. Thus, shares of companies which are tainted with any of the prohibited elements are considered Shariah non-compliant.

 

Ethical Investing

On the other hand, ethical investing means integrating personal values and societal concerns with investment decisions. Ethical investing considers both investors financial needs and the impact of investment on society as a whole. Ethical investing applies ethical and social criteria in the selection and management of investment portfolios. Investors are not only concerned about the financial returns of their portfolios and the risks involved, but also with the characteristics of the companies in which their funds are invested. This includes the nature of the company’s goods or services, the location of the business and the manner in which it conducts its affairs and business operations.

The strategy for ethical investing can either be positive or negative. The positive approach being supportive of companies which are particularly approved of in terms of the products, activities or business methods while the negative approach aims to avoid investing in companies which are involved in unacceptable products or countries or whose business methods are considered as unethical. Investment decision in ethical investing is mainly influenced by ethical issues such as environmental improvement, climate change, genetically modified food products, gambling, human rights violations, military and nuclear power, animal testing, health and safety breaches etc. The concept of ethical investing is consistently evolving to dispense appropriate policies depending on the changing environment. In its most recent adaptation, ethical investing is moving from negative screening to include positive screening to promote positive innovations and contributions to society, no longer simply to reduce the negative impact of business, industrial practices and the environment.

 

Common Values

Despite the differences, halal and ethical investing generally share an ethical investment philosophy which is a value-based approach to align an investor’s portfolio with religious belief. Both focus on real economic activities such as improving living conditions and well being of the people, establishing social equity and preventing injustice in trade and commerce.

Both halal and ethical investing also focus on protection of natural and environmental resources except for institutional financial sectors and invest in the same economic sectors namely industrials, health care, consumer goods, utilities, consumer services and basic materials such as technology. In addition, both apply measures which eliminate a group of firms or complete sectors based on social or religious belief. For instance, industries like tobacco, alcohol and pornography are excluded due to the nature of products and services which are harmful to society.

 

Screening Process

Although both halal and ethical investing use screening process in the management of its portfolios, the application of the screening process should be distinguished. The screening process for ethical investing is monitored by a panel or committees responsible for setting the criteria and establishing an approved list of companies from which the portfolio manager can select investments.

Ethical investing applies the screening process to ensure that the companies they invest to meet their ethical policy. The screening process removes companies considered to be negative and will encourage investment in positive companies. The negative screening avoids some types of investments, for instance, gambling companies or weapon manufacturers. The positive screening, on the other hand, prefers activities or characteristics deemed desirable such as the renewable energy industry or health care. Some fund managers also use ‘best of sector’ rule that selects leading firms in every business sector based on their social and environmental commitment, and “social responsibility overlay’ rule whereby shares for a portfolio are selected according to the usual procedure but a process is added to address issues related to social responsibility.

While the screening process for ethical investing restricts the inclusion of firms that are not conscious of human rights and environmental concerns, halal investing seems to apply a different approach based on compatibility of business activities with Shariah principles. On this point, halal investing is subject to Shariah screening methodology determined by the Shariah Supervisory Board or Shariah Advisors of the fund management companies. In some jurisdictions, for example, Malaysia, the Shariah screening methodology is determined by a centralised Shariah Advisory body established by the regulator i.e. Securities Commission of Malaysia, as the highest authority in the determination of Shariah matters in relation to Islamic capital market activities which includes Shariah-compliant investments.

Shariah screening process generally involves two screening categories, namely the qualitative screening and financial screening. The qualitative screening excludes companies that are involved with non-permissible activities such as alcohol, tobacco, gaming, pork products and conventional banking and insurance. Shariah screening is generally made available by index houses such as FTSE, S&P Dow Jones and MSCI that provide a wider spectrum of Islamic indices to be applied as a benchmark by fund managers. Financial screening is applied using financial ratios to ensure that securities are Shariah compliant which involves calculation of ratios, such as the proportion of interest-bearing debt to assets or ratio of total debt to the average market capitalisation of a company. The wisdom behind financial screening is to avoid investing in debt-embedded securities.

 

Other Considerations

Halal investing is further characterised by strict limitation such as purification process and the exclusion of investment in interest-bearing securities which ethical investing is not subjected to. On this point, halal investing provides for a cleansing of income from investment tainted with impure income through purification. Purification is required when companies are mixed companies which have passed the tolerable benchmark of the Shariah screening process that gives rise to some tainted income generated from the investment. Purification involves giving away a certain percentage of such income to charity as a mean of repentance for getting involved in some level of Shariah non-compliant investments.

In a nutshell, halal and ethical investing are closely related but are not similar. It is submitted that Shariah principles often go beyond the requirements of ethical investment and have the benefit of providing clearer codification and ethical standard together with a mechanism for implementation that is supervised by the Shariah Supervisory Board or Shariah Advisors.

The convergence of values between halal investing and ethical investing concepts highlights the agreement of ethical and social protection. Halal investing screening criteria applies a more standardised approach of negative screening for industries and business that do not comply with the basic halal investing criteria. Whilst there exists diversity in interpretation of appropriate filters in the Islamic investment screening process, the differences are minor and actually harmonising as the market develops and progresses.

Above all, a decision to invest in halal or ethical investment will nevertheless depend on the investor’s own values as well as investor’s overall portfolio and financial planning goals. Investors interested in halal and ethical investment often seek fund managers offering a high level of disclosure and transparency in terms of the investment process, portfolio listings and detailed reporting before making an investment decision.

 

 

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