Many Americans have only the faintest notion of Islamic finance. An obvious reason is that “Islam”is a loaded term in the United States (some might argue “finance” is as well). However, the aversion many banks and investment advisors have to Islamic finance prevents them from accessing wealthy investors and denies many Muslim Americans appropriate investment advice and tools.
Islamic finance is any sort of banking or banking activity that adheres to the principles of Shariah, the moral code and religious law of Islam. For example, Muslims are banned from taking out traditional mortgages for home loans because according to Shariah, they are prohibited from paying or accepting usuries. The 2010 U.S. Religion census reports that Islam has 2.6 million followers and is the fastest growing religion in the United States.
When Muslim Americans buy homes, they finance their purchases through interest-free tools such as murabahah. In a murabahah transaction, a bank buys the property and sells it to a homebuyer at an accepted profit margin, one that often reflects the prevailing interest rates offered by traditional mortgage lenders. The homeowner then repays the loan in installments and the bank is not allowed to charge additional profits for late payments.
Shariah requirements affect not only Muslim Americans’ homeownership, but their investments as well. Even so, finding trustworthy Shariah investment advisors in the United States is difficult. One such advisor, Razor Hedge Investment Management, has created a passive Shariah index that aggregates the assets held by Islamic finance funds in the United States. According to Razor Hedge President Annie Hashmi, even though only one-third of Razor Hedge’s clients are Muslim, many are curious about Shariah investments.
“The average American Muslim family is affluent and earns about 40% more than the average American family,” Hashmi said. “However, many of the American Muslims are first generation immigrants and do not understand or trust the financial markets. They wind up shooting themselves in the foot because they leave money in cash that erodes with inflation, or take excess risk through speculation in real estate or hot stocks tips. Or they invest through advisors who sell them front load mutual funds with excessive fees. We see an important part of our job is providing basic financial education so the American Muslim community, so they can fully integrate with financial institutions and actually achieve the American dream for themselves and their next generation.”
Many Shariah funds often have above-market returns and Hashmi believes there are opportunities for all investors, especially impact investors, not just Muslims.
“Shariah investing principles overlap significantly with socially responsible investing principles,” she continued. “It avoids investing in firms that do harm to society, especially firms that exploit and perpetuate social vices such as gambling, adult entertainment, alcohol, tobacco, and arms. In addition Shariah principles also excludes investing in securities that involve firms that deal with pork products, debt securities, or are excessively leveraged. This last requirement means that the Shariah stock investment are relatively low leveraged, and thus low beta investment securities that have lower volatility than the average listed stock.
Hashmi believes that Shariah investing meshes perfectly with traditional investment strategies and helps to keep investors’ transaction costs low.
“An additional requirement of Shariah investing is prohibition of speculative trading. This plays well with modern understanding of finance,” she said. “It is better to follow an index approach that incur low transaction costs. Accordingly, we have constructed a broad passive Sharia index investment strategy that invests in the US stocks that are Shariah compliant. The index is constructed by evaluating holdings of six Shariah funds in the United States, and aggregating a master list of securities. We then use the relative capital weight of each stock in the master list to construct our passive sharia index.
“Such a passive Shariah index investment strategy is suitable for investors who want to invest in a socially responsible manner, want lower volatility than the stock market, and do not want to take speculative risk. The potential is there for a partnership between Shariah investing and socially responsible investing. However, Shariah investment strategies are not being marketed to socially responsible investors. In the future, they can possibly brand themselves that that manner.”
According to Chicago Microfinance Project President Karen Hunt-Ahmed, charities and microfinance organizations can benefit from investors following Shariah principles.
“Every company that makes money needs to donate some part of its profits if it does not adhere to Islamic principles,” Hunt-Ahmed explained. “For example, if someone invests in a grocery store, much of the profits come from food. However, a portion of those profits come from the sale of alcohol and pork, which is not allowed. Investors must handle it by figuring out what percentage of the profits came from items that did not adhere to Islamic principles. They must then donate those profits to charity. Many of these donations are steered towards Islamic microfinance and put back into the community.”
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