Last fall, Oksana and I met with hundreds of prospective Limited Partners for our new fund. Among those who we realized had the best fit, were a significant number of Muslim investors, and they had some great ideas about how we could improve our fund performance by becoming a Shariah compliant fund.
Investing in Shariah compliant funds has gained popularity in recent years, as investors seek to align their investments with their values and beliefs. Shariah compliant funds follow Islamic principles (but are not limited to Islamic investors) and avoid investments in sectors such as alcohol, tobacco, gambling, and pornography.
Given our unadulterated devotion to ethically improving returns for LPs, we did our research and discovered that Shariah compliance is a fast growing investment market and provides many proven economic benefits to LPs, GPs and portfolio companies, including: higher rates of return, diversity, less volatility in portfolio returns, and better alignment with environmental and social good.
According to a report by the State of the Global Islamic Economy (SGIE) in 2020, the assets under management (AUM) of Shariah compliant funds had grown from $58 billion in 2009 to $121 billion in 2019, representing a compound annual growth rate (CAGR) of 6.7%. The report also projected that the global AUM of Shariah compliant funds would reach $174 billion by 2023. This is pretty impressive when you consider that CAGR is almost double traditional fund inflows.
On the economic benefits, the first advantage of investing in Shariah compliant VC funds is that they offer the potential for higher returns than traditional VC funds. A study by the Islamic Development Bank in 2015 found that the average annual return of Shariah compliant VC funds was 16%, compared to 13% for non-Shariah compliant VC funds. The study also found that Shariah compliant VC funds had a higher success rate in exiting their investments, with 78% of their investments successfully exiting, compared to 62% for non-Shariah compliant VC funds.
Secondly, Shariah compliant VC funds offer investors a way to diversify their portfolios. These funds typically invest in startups that are aligned with Islamic principles, which means they are likely to invest in a range of sectors such as healthcare, technology, and renewable energy. A study by the University of Maryland in 2015 found that Shariah compliant funds were more diversified than non-Shariah compliant funds, which reduced the overall risk of the portfolio. This means that investors can benefit from the potential for high returns from investing in startups, while also reducing the risk of their overall portfolio by diversifying.
Diversity leads to less volatility, our third area of economic benefits. In a study by Khediri and Charfeddine (2016) found that Shariah compliant funds exhibit lower volatility due to the diversification of their portfolios. The study analyzed the performance of Shariah compliant and conventional mutual funds in the Gulf Cooperation Council (GCC) countries and found that Shariah compliant funds had lower levels of volatility. The authors attributed this to the diversified nature of Shariah compliant funds.
Shariah fund reduced volatility is not only from their diversity, but is hard-wired into their selection process. According to a study by El-Gamal et al. (2017) found that the screening process used by Shariah compliant funds tends to exclude companies that are highly leveraged, which can reduce the risk of investment losses in volatile market conditions. The authors also noted that Shariah compliant funds tend to focus on long-term investments, which can lead to a more stable investment portfolio. Holy alpha!
Fourth, investing in Shariah compliant VC funds can provide investors with a way to make socially responsible investments. Shariah compliant funds avoid investing in sectors that are deemed harmful to society or the environment, such as alcohol and tobacco. This means that investors can align their investments with their values and beliefs, while also potentially generating higher returns. A study by the Harvard Business Review in 2017 found that companies that focus on social and environmental issues tend to outperform those that do not, which suggests that investing in socially responsible startups can lead to higher returns.
And as a secret bonus, Shariah compliant VC funds offer investors access to investment opportunities that are not available through traditional VC funds. These funds tend to invest in startups that are based in emerging markets, such as Asia and the Middle East, which have high growth potential but may be overlooked by traditional VC funds. A study by the University of Cambridge in 2017 found that Islamic finance institutions were more likely to invest in small and medium-sized enterprises (SMEs) than conventional finance institutions, which suggests that Shariah compliant VC funds may be more likely to invest in startups that are in the early stages of development and have higher growth potential to late-stage VC funds.
So yeah, we went all-in for Sharia compliance with zero regrets! Yeah, we want to generate higher returns with greater diversification, less volatility, invest in a sustainable and socially responsible manner, provide access to unique investment opportunities, and crush benchmarks for top decile funds. While there is no guarantee of returns with any investment, the academic research and published studies suggest that investing in Shariah compliant VC funds can be a viable option to make all our GP dreams come true.
If you’d like to learn more about Shariah compliance and VC investing, here’s links to the articles we mentioned above, and a few more we found interesting. Enjoy!
- Report by the State of the Global Islamic Economy (SGIE) in 2020: https://halalfocus.net/report-on-state-of-global-islamic-economy-2020-2021/
- Study by El-Gamal et al. (2017) on corporate governance in Islamic finance: https://www.oxfordislamicstudies.com/article/book/islam-9780195177831/islam-9780195177831-chapter-45
- Study by Khediri and Charfeddine (2016) on Shariah compliant funds in GCC countries: https://www.sciencedirect.com/science/article/pii/S0927538X16300237
- Study by Chaieb and Khediri (2018) on performance and volatility of Islamic and conventional mutual funds in Tunisia: https://www.emerald.com/insight/content/doi/10.1108/JFRA-05-2017-0051/full/html
- Article by Islamic Finance News on the performance of Shariah compliant funds: https://www.islamicfinancenews.com/shariah-compliant-funds-less-volatile
- Report by PwC on the growth of Islamic finance: https://www.pwc.com/m1/en/islamic-finance/assets/if-growth-m1-eng.pdf
- Report by EY on the outlook for Islamic finance: https://www.ey.com/en_gl/financial-services/the-outlook-for-islamic-finance-in-2019