Halal investing
ESG and Halal Investing – Redundant or Complementary?
Hazem Hamoudia
2024-08-03
7 mins read
Abstract
As the landscape of investing evolves, more investors seek strategies that align with their ethical beliefs. Halal investing and Environmental, Social, and Governance (ESG) criteria represent two prominent approaches that address these concerns. This article explores how these investing approaches co-relate and how they can be integrated effectively.
Introduction to Halal and ESG Investing
Halal Investing
While often associated with Islamic dietary laws, 'Halal' extends to all aspects of life, including investing. Halal investing allows Muslims to participate in capital markets while adhering to Shariah guidelines, which emphasize stability, sustainability, and ethical practices.
Shariah law prohibits investments in companies involved in interest (riba), activities harmful to society (mūnkar), and transactions involving excessive uncertainty (gharar). It mandates risk-sharing, ensuring that both parties in a transaction bear the outcomes together.
Islamic scholars have developed standardized approaches for Halal compliance screening of stocks, such as the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) standards. These approaches generally include:
1. Business Screening: Excluding companies engaged in impermissible activities, such as gambling, the production or sale of alcohol and pork, or conventional banking.
2. Financial Screening: Excluding companies with interest-based earnings and levels of debt and assets that exceed permissible thresholds. For instance, AAOIFI guidelines stipulate that interest-bearing debt must be less than 30% of a company’s market capitalization to be considered Halal compliant.
ESG Investing
ESG stands for Environmental, Social, and Governance, three key factors in assessing a company's sustainability and societal impact. ESG criteria help investors evaluate ethical behavior and long-term viability.
1. Environmental Criteria (E): Examine a company’s impact on the environment, including pollution, greenhouse gas emissions, resource use, and energy efficiency.
2. Social Criteria (S): Focus on a company’s societal impact, such as employee treatment, diversity, and human rights in the supply chain.
3. Governance Criteria (G): Ensure transparent accounting practices, integrity in leadership, and accountability to shareholders, covering compliance with laws and anti-corruption measures.
ESG investing has gained prominence since the early 2000s, with studies indicating that socially responsible companies often perform better financially. Initiatives like the UN’s Principles for Responsible Investment (PRI) have further solidified ESG’s place in the investment world, with thousands of signatories managing trillions in assets.
ESG does not clearly exclude parts of prohibited businesses, such as the pork industry, nor does it address inequalities caused by excessive interest-based business models.
ESG does not fully cover the requirements of Halal investing.
Integrating Halal and ESG Criteria for the Capital Market
Halal and ESG From an Islamic Perspective
Halal investing is rooted in Islamic legal principles to ensure Shariah compliance. While Shariah screening covers specific criteria with concrete thresholds, comprehensive due diligence by investors is crucial to fully adhere to Islamic principles.
Islamic jurisprudence (fiqh) categorizes actions into five groups:
obligatory (fardh),
encouraged (mandūb),
permissible (mūbah or halal),
discouraged (makrūh),
and forbidden (haram)
Halal primarily refers to permissible actions, but striving for encouraged is key in Islamic guidance.
Considering ESG criteria aligns with investing according to Islamic principles as Islamic sources (Quran and Sunnah) emphasize environmental protection, human dignity, and social justice.
ESG standards complement Halal criteria, towards a comprehensive value-based investing within the context of Islamic jurisprudence.
Opportunities and Challenges with Integrating Halal and ESG Investing
Integrating ESG criteria into Halal investing can provide widely recognized benefits:
- Broader Perspective: ESG criteria address contemporary challenges, complementing the narrow Halal framework, as they are aligned with Islamic principles.
- Improved Data Availability: The rise of ESG investing has improved data quality and availability, which can be leveraged for an extended Halal screening.
- Crisis Resilience: Statistics show that companies adhering to ESG criteria often perform better during crises, a trait likely shared by Halal-compliant companies due to their focus on ethical practices and risk management.
While integrating ESG into Halal investing offers clear benefits, it also presents additional layers to existing challenges in Halal and ESG evaluation, in particular:
- Evaluation Complexity: Lack of standardized methods for integrating Halal and ESG can make objective evaluation difficult.
- Higher Costs: Halal and ESG funds often have higher fees due to active management and extensive analysis.
An Example of Comprehensive Value-based Investing
purepofo is an innovative web application that assesses Halal compliance and stock quality for thousands of stocks using big data. It compiles stock quality based on key indicators such as dividend yield, reliability of dividend payments, net income, profit margins, and free cash flow trends. By benchmarking Halal stocks against the entire stock market, purepofo strives to identify the top-rated stocks among their peers.
purepofo offers a holistic view that encompasses both Halal compliance and performance screening, including portfolio management.
In the context of Halal and ESG investing, purepofo integrates Halal and ESG criteria within a broad Halal compliance check. On top of business and financial screening using AAOIFI standards, it considers discouragement and encouragement factors, including environmental and social scores.
purepofo provides you with a One-Stop-Shop solution for a continuous benchmarking and optimization of your Halal stock portfolio. It supports you making informed decisions on investing in Halal stocks based on broader Islamic principles.
Conclusion
Integrating ESG criteria into Halal investing is not only complementary but enhances the ethical and sustainable investment landscape. By leveraging innovative tools like purepofo, investors can achieve a comprehensive and informed approach, aligning their portfolios with both Islamic principles and contemporary ethical standards, while not sacrificing stock performance and return requirements.
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