Earlier this week Pension Funds Insider spoke to Chris Gower, head of European consultant relations at HSBC, to find out more about Sharia compliant investing, its agreement with NEST and the Life Amanah Pension Fund

The UK government's national savings scheme, NEST, recently announced that HSBC was its choice of fund manager for its Sharia investment mandate. Islamic finance is all about financial activities which are compliant with Sharia law. But what does it entail?

Essentially, it involves finding ways to get financial exposure which is consistent with Islamic law. Investments in tobacco, pornography, arms, gambling, and alcohol, for example, are not allowed. No morally deficient investments are considered pure: everything has to follow the guiding principles of Islam.

"It is not an exact science, so there's no unique path we can follow," says Gower. "There are different interpretations. That is why every company in this business needs to make sure they get advice.

"Often, as is the case with our fund, this happens through scholars who act as consultants and discuss the various investments that are to be made. They tell us whether or not they are Sharia compliant," says Gower. "They set the standards so that our product does meet the criteria and they advise us on what is acceptable. It is a specific investment process that we have to put out in a specific investment universe, all in accordance with Islamic law."

The fund follows a quantitative passive method. "We choose from the MSCI World and the Dow Jones Islamic Titans Index," says Gower.

What is unusual it that the fund can have no exposure to financials. A conventional investment fund which has developed a benchmark based on investments in financials can lead to exposure in the sector of around 20%. This practice leads to the Islamic index being overweight in the oil and gas sector and the healthcare sector.

Purification

"Sharia funds also use a very specific purification technique when it comes to income in terms of dividends," says Gower. "We have to segment the income from dividends from income which stems from any of the sources that are not Sharia compliant." 

He explains that it is sometimes difficult to completely adhere to. "The fund receives dividend income as part of a company's normal business activity. As it is often unavoidable, some of this income will include some form of interest, it will then be necessary to purify this income."

HSBC uses the proportion of the income received from non-compliant activities to pay into the 'HSBC in the Community Middle East Foundation' and the dividend is thereby purified.

For example, a large diversified corporation may be Sharia compliant, however this company may own a small finance subsidiary deemed non-compliant. A percentage of the dividend representing the profits from the subsidiary would then be donated to the 'HSBC in the Community Foundation'.

Returns

"Return wise the fund that we have selected and put on our platform was launched in April 2004. Since then it has increased cumulative returns of about 62% against a benchmark of 64%. So we are looking to match the return of the indexes," says Gower.

"The timeframe has been odd, we didn't have 'normal years' [the crisis], but over the past five years the benchmark has returned roughly 6.5% per year annualised," he explains.

"Year on year the returns coming from the constituent sectors and stocks are a function of a large variety of investables so you see very different reactions. For example during the financial crisis the fact that the universe of the Dow Jones Islamic Index had a lot less in financials meant that therefore it fell a lot less than a broader index would have done, or indeed did." 

In terms of expectations of the fund Gower explains that HSBC works with a large number of UK defined contribution (DC) pension schemes. Offering pensions to those believing in Islam has been something that consultants, the various platforms and the schemes themselves have taken on board over the years and as a result they have offered individual investors the opportunity to invest as they prefer. The fund opens up an investment universe to investors who would maybe otherwise not have the possibility to save for their retirement.

"We run around £50mn in total in this passive strategy, which has grown from zero in 2004. We think it will grow as the trend in DC, and awareness and education on this type of investment continues. This is something we are working on together with NEST and our other clients; we want to communicate and educate.

Gower says the fund is looking forward to working together with NEST. "It is going to raise the profile of this type of investment. Sharia funds offer a way for people who want to invest according to Sharia law access to the equity market and get a 'return' through acceptable investment themes," he says.

"The other clients of the fund will merely benefit from NEST's choice as the fund just gets bigger. It will be an interesting time."

azeevalkink@wilmington.co.uk  

First published 04.05.11