Is Halal Investing Compatible With ESG Goals?

Can halal investing principles align with the increasingly popular Environmental, Social, and Governance (ESG) standards? It’s a topic gaining traction as more investors seek to blend ethical guidelines with financial growth. PricewaterhouseCoopers recently highlighted this convergence by stating, “Understanding the similarities between ESG and Islamic Finance investment principles holds the key to opportunities for banks and asset managers in the Middle East.”

This article explores the growing relationship between Islamic finance and ESG investing, highlighting the vast opportunities emerging in the Middle East and beyond.

The Intersection of ESG and Islamic Finance: A Growing Opportunity

The global Islamic finance market is on the cusp of dramatic expansion, driven by its alignment with ESG goals. With $35 trillion in ESG assets globally — a number projected to reach $53 trillion by 2025, accounting for one-third of all investable assets — the opportunity for growth is undeniable. While Shariah-compliant funds have grown over 300% in the last decade, totaling approximately $200 billion, the adoption of global regulatory and legal standards could propel their growth even further.

If Islamic finance funds and ESG investments aligned their standards, both would benefit. Islamic finance principles inherently address issues of sustainability and ethical investing, providing a natural synergy with ESG’s focus on environmental stewardship, social responsibility, and corporate governance.

The Core Principles of Islamic Finance and Their ESG Overlap

According to global accounting firm ACCA, Islamic finance is built on a few foundational principles, which closely parallel those found in ESG investments:

• Ethical Wealth Generation: Islamic finance emphasizes that wealth should be generated through legitimate trade and asset-based investments. Speculative practices or “making money from money” are expressly prohibited, encouraging a focus on real economic growth.
• Social and Ethical Benefits: Investments should deliver social and ethical benefits beyond financial returns, prioritizing community welfare, poverty alleviation, and responsible business practices.
• Risk Sharing: There is a preference for shared risks and rewards between investors and businesses, fostering fairness and transparency in financial dealings.
• Avoidance of Harmful Activities: Islamic investing prohibits engaging in activities detrimental to society and the environment, such as alcohol, gambling, and interest-based lending.

These principles reflect many of the values underlying ESG investments, from environmental protection to ethical social practices. This alignment offers an opportunity to create a common foundation that can influence global business operations, particularly in conservative markets like the Middle East. The potential impact is vast, given that the global Muslim population stands at around 1.8 billion, or roughly a quarter of the world’s total population.

Bridging ESG and Islamic Finance for a Global Impact

The convergence of ESG and Islamic finance is already in motion. A recent study by Maybank Islamic Berhad found that more than one-third of financial professionals in Islamic finance expect significant growth in funds offering both ESG and Shariah compliance over the next two years. However, 73% of financial firms noted a gap in meeting demand for ESG products that also comply with Shariah law.

To address this demand, new products that blend both ESG and Islamic finance criteria could transform the sector, particularly in markets like North America where ESG funds are rapidly growing in popularity. Dato’ Mohamed Rafique Merican, CEO of Maybank Islamic, noted, “Islamic Finance is indeed growing strongly, but we believe the growth could be further boosted if it was able to offer Shariah and ESG-compliant funds globally. This study shows that demand would rise from both traditional and non-Muslim investors.”

The Growth Challenge: Global Standards and Regulation

Despite the growth potential, a lack of global regulatory and legal frameworks poses challenges. Shakeeb Saqlain, founder and CEO of IslamicMarkets.com, emphasizes the need for standardized guidelines that can be adopted worldwide. The Maybank study revealed that 72% of those surveyed believe the adoption of a unified Shariah and ESG framework would boost investment demand from non-Muslims more than from Muslims.

Abdelilah Belatik, Secretary-General of the Islamic Financial Services Industry (IFSI), echoed this sentiment in a 2022 report: “With the growing market for ESG investing, Islamic funds possess a huge growth potential and are expected to play a prominent role in the Islamic financial services industry in the coming years,” particularly if sustainability criteria are widely incorporated.

Why Shariah Funds Are Lagging Behind ESG Funds

Though ESG and Shariah principles share common ground, Shariah-compliant assets under management have not kept pace with ESG’s explosive growth. One possible reason, as suggested by Schroder’s report, is the limited range of Sharia-compliant products that often lack an explicit sustainability focus. This shortcoming pushes investors who are interested in ESG factors toward traditional sustainability products rather than Shariah-compliant options.

Furthermore, Schroder’s Head of Distribution for Southeast Asia, Lily Choh, highlighted that adding sustainability to a Shariah portfolio “recognizes that sustainability principles are at the core of Islamic beliefs.” However, this aspect has not been sufficiently emphasized among conventional Shariah investment products.

Monem Salam, Executive Vice President of Saturna Capital, offered another perspective: “When it comes to ESG standards, we in the world of Shariah investing are in a different place. There are no centuries-old guidelines to steer standardization.” He suggests that Islamic investing’s practice of utilizing an advisor to audit funds could inspire ESG funds to adopt a similar system of third-party verification to maintain transparency and compliance.

Saturna Capital: A Case Study in Sharia-ESG Alignment

Saturna Capital stands out as a U.S.-based provider of Shariah-compliant mutual funds that also adhere to ESG principles. The Amana fund family, which totals over $5 billion in assets, aligns with both Islamic guidelines and ESG considerations, filtering out companies involved in interest-based activities, gambling, tobacco, alcohol, and weapons manufacturing.

In terms of performance, these funds have shown promising returns. The Amana Growth Fund (AMAGX), the largest Shariah-compliant fund in the U.S., outperformed the S&P 500 in 2021 and over 10 years, returning nearly 33% over three years compared to the S&P’s 26%. This performance demonstrates that Shariah-compliant and ESG-focused funds can be both ethical and profitable.

The Path Forward: A Unified Investment Strategy

Combining ESG and Islamic finance principles has the potential to not only create robust investment opportunities but also influence corporate behaviors toward more sustainable and ethical practices. Eric Pan, CEO of the Investment Company Institute, emphasized this shift: “There’s been increasing recognition that ESG, whether it be climate or diversity, actually affects the value of companies. Naturally, investors would want their portfolios to reflect those factors.”

By fostering a unified approach, companies following both ESG and Islamic finance guidelines may deliver better returns and contribute to a more sustainable, socially responsible global economy. While challenges remain, particularly in creating a universal standard, the opportunities for growth, alignment, and impact are immense — offering investors a chance to make a positive difference while seeking financial returns.