Fund Management: Bridging the gap between ESG and shariah-compliant investing

This article first appeared in Personal Wealth, The Edge Malaysia Weekly, on August 10, 2020 - August 16, 2020.

Photo by Kenny Yap/The Edge

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ESG (environmental, social and governance) investing and shariah-compliant investing share similar objectives in that they promote stewardship and societal value creation. However, the two strategies are often viewed as distinctly separate approaches by investors.

This is something Shahariah Shaharudin, who was appointed president of asset management firm Saturna Sdn Bhd in February last year, wants to change. According to her, bringing together sustainable, responsible and Islamic investing methodologies can do much to invigorate the Islamic asset management industry and complement conventional strategies.

There is already a paradigm shift underway in the Islamic finance industry, which is moving towards being better able to support a more sustainable future, says Shahariah. She points out that shariah investing, like ESG investing, promotes responsible behaviour.

The most widely known aspect of shariah-based investing is the prohibition on interest, security lending and short selling. The strategy also employs a negative screening process when dealing with industries such as tobacco, alcohol and breweries, weapons and armaments as well as other non-halal products.

ESG investing, on the other hand, uses positive screening as a means of selecting the best performing companies, which set a positive example of dealing in environmentally friendly products and engaging in socially responsible business practices. Thus, ESG analysis looks at more intricate issues to mitigate risks and enhance long-term returns.

Integrating ESG factors with Islamic finance practices is therefore consistent with the fundamental principles of shariah and encourages investors to pursue sustainable risk-adjusted investment returns, says Shahariah. “Islamic teaching is all about promoting equality, social justice, inclusion and economic prosperity.

“Shariah-compliant investing filters using negative screening — we weed out prohibited sectors. ESG filters via positive screening, where we get to enjoy the best that companies have to offer.

“That is why I believe shariah-based investing is at an inflection point. As the principles of shariah and ESG converge, we can expect to improve the overall risk-adjusted returns.

“I want to build investors’ trust in Islamic and ESG investment performance. Many investors still think that Islamic investments tend to underperform their conventional counterparts. Studies have proved that shariah and ESG investing do not diminish the return potential.”

Saturna is a wholly-owned subsidiary of US-based Saturna Capital Corp, which manages US$4.3 billion (RM18.1 billion) in assets globally. Two of its most well-known funds are the Amana Income fund (AMANX) — which has US$1.27 billion under management and focuses on capital preservation and income generation — and the Amana Growth fund (AMAGX), which manages US$2.24 billion in assets and aims to achieve double-digit earnings growth. AMANX and AMAGX saw returns of 8.68% and 17.7% respectively for the three years ended June 30. “Apart from being shariah-compliant, these funds are also ESG-focused. Both funds have proven track records and that is an indication that Islamic and ESG funds can perform as well as conventional funds,” says Shahariah.

As both ESG and shariah-compliant funds are considered defensive asset classes, they performed relatively well during the recent market downturn triggered by the Covid-19 pandemic. “Our portfolios are more defensive, so they provide downside protection during stressful times. Since most ESG and shariah investors are long-term and value investors, these funds do comparatively well over time,” she says.

Locally, Saturna manages two shariah-compliant equity unit trust funds — the ICD Global Sustainable Fund and the Asean Equity Fund.

Training clients to look at the long term

Shahariah, who previously served as CEO and executive director of Kenanga Islamic Investors Bhd, says her experience at Saturna so far has been very different from her previous role. “[From my previous experiences,] many domestic [and Asian investors in general] tend to think short term. They want high returns and they want these fast.

“These investors tend to ask whether our market outlook has changed. In reality, we cannot be changing our market outlook all the time because there needs to be some consistency [in our house view], unless a very big event changes the investment landscape. Then, we need to shift our position.

“At Saturna, however, clients are trained to look at values that are beyond profit. They are encouraged not to put too much focus on short-term trends, which is why the firm places a strong emphasis on research.

“Existing and emerging trends are thoroughly analysed before we decide to take a position. We look at geopolitical developments, technology trends, industry themes, company leadership and ESG considerations as well as other factors that will affect our investments beyond three to five years.”

The Covid-19 pandemic is proving to be a major turning point for both shariah and ESG investing as investors are finally realising how these filters can come in handy during a crisis, she says. “We expect people to change their preference to products that include sustainable and responsible elements alongside traditional financial metrics. And we are here to offer alternatives to help them diversify their investments.”

Some of the sectors that the firm focuses on are healthcare, technology and consumer goods. “We believe the technology sector will continue to do well as it is driven by secular growth trends around artificial intelligence, the Internet of Things, big data, automation, and smart homes and automobiles. We invest in technology companies which we believe will benefit from these trends over the long run,” says Shahariah.

“We expect the healthcare sector to benefit from drug discoveries, consolidation, innovation and the rise of infectious diseases such as Covid-19. However, the consumer sector has tailwinds from changing consumer habits amid the pandemic, e-commerce, customisation and an increased focus on health and nutrition, among others.”

Saturna also favours investments in companies that value diversity, human rights, gender equality, climate protection and employee health and safety, she says.

“Going forward, we expect the uncertainty to diminish a little as progress is made towards the development of a Covid-19 vaccine. The massive fiscal and monetary stimulus packages around the world will continue to provide a floor to the markets,” says Shahariah.

“We believe our sustainability and shariah-focused funds are well positioned for positive or negative developments, given our focus on low-debt, cash-generative and high-quality companies. Such characteristics are defensive in the event of a downturn while our low debt focus will be an advantage in the event the economies regain momentum. Historically, shariah funds tend to outperform in relative terms during financial stress.”

While fixed-income securities are not investors’ best bet as a hedge against the risks posed by the ongoing pandemic, there are still investment-grade corporate bonds that provide high-quality yields, says Shahariah. “With yields coming off, going into bonds will not be the preferable option for investors. But there is no harm if you already have an existing bond mandate because you went in for the yield when it was higher and saw capital appreciation. Nevertheless, there are always opportunities when investing in fixed income, but it depends on the investors’ risk appetite.

“Recently, the bond or sukuk market has come under stress. However, there are still attractive fixed-income opportunities in selected sovereigns such as Australia and the Gulf Cooperation Council member countries. Investment-grade corporate paper also offers attractive yields, especially issuers that have embedded ESG practices.”