Halal Screens and Performance

7/11/2013 10:51:25 AM

Contribution by Omar Ezz, CFP - Azzad Investment Advisor

The Azzad investment process begins by filtering companies for compliance with our ethical Islamic investment philosophy. Our proprietary software tool (the Investment Screening/Filtering Application, or ISFA) has the capacity to screen thousands of public companies domestically and abroad to ensure that investment selections are consistent with clients’ values. Using this process, Azzad defines the universe from which investment managers may choose, allowing those managers to focus on identifying promising companies using their expertise and investment strategy. Many Muslim investors wonder how the ISFA screens affect the performance of their portfolios. Some point to Azzad’s lack of exposure to financials during the Financial Crisis of 2008 as proof that ISFA will insulate them from underperformance. Others look at the resurgence of financials following the recent recession and worry that their performance may lag traditional portfolios and their benchmark indices. Who’s right? As we’ll see below, the answer, in part, depends on how you define the time period.

Although no thorough studies have been done to compare the performance of traditional and Halal portfolios, one way to begin exploring the question of how screens impact performance is by comparing a traditional index to its Islamic counterpart, making sure both have the same investment objective.

For the purposes of discussion, we’ll use indices instead of actively managed portfolios because over or underperformance can be attributed to the stock selection of the portfolio manager with the latter. An index’s performance, however, is determined primarily by the investment criteria it follows.* We’ll take a look at the Dow Jones U.S. Total Return Index versus the Dow Jones Islamic Market U.S. Total Return Index, in addition to the Dow Jones Global Total Return Index versus the Dow Jones Islamic Market World Total Return Index. That way, we’ll be able to see differences both domestically and globally. The annualized returns of these indices during various market cycles are shown here:

Dow Jones Indices - Conventional versus Islamic

Since the Dow Jones U.S. Total Return and the Dow Jones Global Total Return have much longer track records than their Islamic counterparts, we use the earliest date that the comparable indices have in common to illustrate long-term performance. The earliest common date is January 1996.

The table shows that the Islamic indices outperform when the industries they don’t invest in underperform, like the Great Recession when financial services were the hardest hit sector. The opposite is also true, as was the case in 2012 when financial services were one of the top performing sectors.

There are also sectors in which Islamic indices are more heavily concentrated—technology, for example. When the tech sector over performs, Islamic indices tend to outperform their traditional counterparts, as we saw before the Dot-Com Bubble burst. Based on the table, the opposite also appears to be true. Look at what happened after the Bubble burst. Islamic indices plunged further than the conventional indices.

Perhaps the most interesting observation, however, is that when you compare the long-term performance of the indices (shown in the column on the far right), the Islamic indices outperform. Why? There are probably several reasons, but this is likely due to the longer-term underperformance of prohibited industries like financial services combined with the longer-term over performance of permissible (and often overweight) industries like technology. Only time will tell if this trend will continue. As the investment advisory industry disclaimer goes: Past performance is not indicative of future results!

*Even though you can’t invest directly in an index, the goal of this exercise is to offer a comparison between a filtered universe of stocks versus an unfiltered index. The Azzad Funds, as well as the portfolios in the Azzad Ethical Wrap Program, are actively managed, which means that they use portfolio manager skill to select permissible companies. As a result, your portfolio results will differ from straight index returns.


Opinions expressed are those of the author or fund manager, are subject to change, are not guaranteed and should not be considered recommendations to buy or sell any security and should not be considered investment advice.

Fund holdings and sector allocations are subject to change and are not a recommendation to buy or sell any security. Click here for Azzad Ethical Fund current top 10 holdings. Click here for the Azzad Wise Capital Fund current top 10 holdings.

Past performance does not guarantee future results.

The Azzad Ethical Fund is non-diversified and may invest a larger percentage of its assets in fewer companies exposing it to more volatility and/or market risk than diversified funds. The Fund may not achieve its objective and/or could lose money on your investment in the Fund. Stock markets and investments in individual stocks can decline significantly in response to issuer, market, economic, political, regulatory, geographical, and other conditions. Investments in mid-cap companies can be more volatile than investments in larger companies. Investments in growth companies can be more sensitive to the company’s earnings and more volatile than the stock market in general. Because the portfolio may invest substantial amount of its asset in issuers located in a single country or in a limited number of countries, it may be more volatile that a portfolio that is more geographically diversified. See the prospectus for more details about risks.

Investments in smaller and medium sized companies involve additional risks such as limited liquidity and greater volatility. Investments in debt securities typically decrease in value when interest rates rise. This risk is usually greater for longer-term debt securities. Investments in lower rated and non-rated securities present a great risk of loss to principal and interest than higher rated securities.

The Azzad Wise Capital Fund is non-diversified with a high concentration of securities in the financial sector which can expose the Fund to more volatility and/or market risk than diversified funds. The Fund may not achieve its objective and/or could lose money on your investment in the Fund. The Fund mainly invests in securities issues by foreign entities which expose the Fund to country specific risks such as market, economic, political, regulatory, geographical, and other risks. The Fund intends to invest in certain instruments that may be illiquid. As a result, if the Fund receives large amount of redemptions, the Fund may be forced to sell such illiquid investments at a significant loss to be able to meet such redemption requests. See the prospectus for more details about risks.