Finding an Oasis of Profit for Islamic Investors
Oasis International Equity Fund, which invests according to Islamic law, won’t invest in shares of companies involved in peddling alcohol, gambling or pornography. Banks and financial services are out as well, since the fund is aimed at Islamic investors, for whom earning interest is an unacceptable way of generating profit.
Those taboos can make investing in international equities a bit tricky, and many Muslims have chosen to forgo the superior returns historically available from stocks over cash-based investment, so as not to compromise religious principles.
Oasis, an $18-million offshore fund registered in Luxembourg, invests according to Islamic law, or Sharia. All investments must meet the approval of the Sharia supervisory board made up of eminent Islamic scholars.
“I thought the restrictions we were going to be operating under would mean the list of stocks would look so peculiar that we wouldn’t be able to construct a portfolio at all,” said the fund’s investment director, Neil Honebon of Fleming Investment Management Ltd., part of the Robert Fleming firm.
In the eight months Oasis been operating, the value of its units has risen 10%. Even if that lags the benchmark Morgan Stanley Capital International World Index over the same period, it’s still better than the cash-based returns that are the standard option for Islamic investors.
Shares of companies whose activities conform to Islamic principles are selected from among the Morgan Stanley Capital International universe of 2,600 stocks.
That’s cut down to about 1,000 stocks by excluding those engaged in un-Islamic activities. Financial service companies account for close to 500 excluded stocks. Companies that earn substantial sums on cash balances, or those that are highly leveraged, will also be sidelined, Honebon said.
The prohibition against alcohol excludes not just brewers and distillers. Any company with revenue from the sale of booze or other intoxicants is also ruled out, so there are no hotels, supermarkets or restaurant chains.
Gambling is banned; therefore, no casinos or bookmakers are allowed. You also won’t see Cadbury Schweppes, bank note printer De La Rue or Racal Electronics--companies with major stakes in Camelot Group, operator of the U.K. National Lottery.
Property companies are risky because one can’t control whom they’re renting to. Mainstream publishers could also be transgressors. News Corp., for instance, publishes tabloid newspapers featuring photos of topless women.
The exclusions applied to Oasis are similar to those of many ethics-based funds, other than that their typical bugbears such as the defense, tobacco or nuclear industries are perfectly acceptable under Sharia.
After meeting Sharia criteria, another five investment screens--looking at dividend history, growth prospects and valuations--are used to whittle the universe down to about 300 blue-chip stocks.
“We’re trying to have a portfolio that looks as much as possible like the world index,” Honebon said. “What we’re actually interested in finding is superior and consistent dividend growth.”
The fund currently holds 86 companies and is aiming for between 100 and 120 as it expands.
As of Dec. 1, the U.S. made up 40% of the assets, followed by Japan with 21%. European stocks together are 27% of the fund’s investments, with the rest in the Asia-Pacific region.
Having weeded out un-Islamic stocks, the fund ends up with an above-average weighting in other industries such as utilities, telecommunications and oil companies.
Recognizing that almost any company will earn some interest on its bank deposits, a deduction is made from the fund’s assets to compensate. This “purification” has been running at about 0.7% of assets, with the sums donated to Islamic charities.
The best-performing stock in the portfolio has been Intel Corp., which has more than doubled since March.
Other major holdings include Bristol-Myers Squibb Corp., Emerson Electric Co., Exxon Corp., Roche Holding and Toyota Motor Corp.
Sectors excluded from the portfolio for religious reasons have typically shown both higher volatility and greater returns than the MSCI World Index average.
Nonfinancial stocks have under-performed the MSCI World by 0.2% over the last 20 years, Honebon said, while some performance is also sacrificed by excluding many consumer-oriented stocks that will benefit from economic growth.
However, since it invests mainly in international blue-chip companies, Oasis should turn out to be less risky than average.
“It’s a fairly defensive portfolio,” said Chris Mason, sales director of Flemings in Bahrain. “We don’t expect Islamic investors to shoot the lights out their first time into equities.”
Oasis has only been running since March 31, so longer-term performance figures aren’t available. In its first eight months, it’s gained 10.3%, or 9.95% after expenses, including Sharia purification. That compares with an 11.2% gain for the MSCI World.
“If you are going to have principles, it’s going to cost you money,” Honebon acknowledged.
Another fund with similar objectives, except for the Sharia exclusions, and managed by the same team, is the Fleming International Equity fund. That’s up 79% since its introduction in 1988, compared with a 70% gain for the MSCI World, according to figures from Micropal Ltd.
Honebon, 43, who has been with Flemings for 16 years, is head of quantitative research of Fleming Investment Management and specializes in asset allocation. He says he has enjoyed the challenge of constructing Oasis.
“After so many years in the business, you need something to refresh a jaded palate,” he said. “This has been an exciting project.”
Flemings has $92 billion under management worldwide, about 10% of that from Middle Eastern investors.
The chairman of the Sharia Supervisory Board is Mohammed Taqi Al-Usmani, deputy chairman of the Ficq Academy of Jeddah and a former member of the Sharia bench of the Supreme Court of Pakistan.
Costs of the fund are above average for offshore international equity funds. In addition to the annual management fee of 1.75%, the fund’s introduction costs of $400,000 are being written off against assets over five years, and the fund must meet the expenses of complying with Sharia.
The fund is not subject to any tax on its income or capital gains, other than irrecoverable withholding taxes on investment income in the country of origin. The fund pays a tax of 0.06% of its net asset value each year.
As with any fund, investors should get advice on how capital gains and dividends will be taxed.
Oasis offers a broad international equity portfolio for those who are committed to complying with Islamic law with regard to their investments.
“Some are more austere than others, and those people are not convinced in investing in equities at all,” Honebon said.
The selection restrictions and financial impact of complying with Sharia mean Oasis is unlikely to be suitable for those primarily interested in performance.
After this year’s boom in world stock markets, some analysts are warning that equities could be in for a rougher time in the months ahead. U.S. shares fell this week on concern that prices aren’t justified by earnings prospects.
“Global markets aren’t so independent that a major move in the U.S. won’t have an effect in Europe,” said Oliver Kamm, European equities strategist at James Capel & Co.
However, like all equity investments, the fund should be considered over a longer term. Historically, equities have outperformed cash and bonds, and the blue-chip nature of the underlying investments of the fund should underpin continuing growth.
Oasis is structured as an umbrella fund, so as demand develops additional subfunds could be instituted. Mason says the next move could respond to interest from Middle Eastern investors in extending the approach to emerging markets.
