Islamic finance and responsible investment

Responsible investment gaining traction among Islamic investors

Several mainstream asset managers and banks that are signatories to the PRI offer access to Islamic windows, sukuk or Sharia equity funds. The PRI signatory base also includes investors in OIC countries, some of which are partly or fully mandated to invest in a Sharia-compliant manner. Notably, almost half of the signatories in OIC countries joined the PRI in the last three years, signalling growing interest in responsible investment among Islamic investors.

The main drivers of signatory growth in OIC countries are the strong alignment of social objectives in responsible investment and Islamic finance, and the additional financial value of integrating environmental, social and governance (ESG) factors into investment processes – which can be combined with Sharia screening. As Islamic investors pursue sustainable risk-adjusted investment returns, integrating ESG factors into their decision-making can improve investment performance while aligning financial objectives with social and environmental goals.

What is responsible investment?

The PRI defines responsible investment as an approach to investing that incorporates ESG factors into investment decisions to better manage risk and generate sustainable, long-term returns.

Some institutional investors once believed that ESG issues were irrelevant to portfolio value, and therefore not consistent with their fiduciary duties. However, this assumption is no longer supported, as set out in the PRI’s recent report, Fiduciary duty in the 21st century. ESG factors are critical to performing effective risk and return analysis. Responsible investment does not necessarily involve narrowing the available investment universe. Nor does it involve relegating the pursuit of a financial return to unrelated objectives (social or ethical). It does, however, provide investors with an expanded set of tools to evaluate the operational performance and financial prospects of investee companies.

Institutional investors can practice responsible investment in several ways, including:

• integrating ESG information into quantitative and qualitative analysis (such as fundamental analysis of company value in equity investing or assessment of creditworthiness in fixed income investing), which could result in adjusting areas such as selection, weighting or asset allocation;
• engaging – either individually or alongside other investors – with investee companies/entities on the ESG factors identified as relevant to them;
• using shareholder voting rights to influence company behaviour;
• encouraging investee companies/entities to disclose information on the ESG factors that do or could affect them;
• monitoring overall ESG risk within the portfolio by measuring its carbon footprint, for example;
• helping to shape investor-relevant public policy;
• promoting wider acceptance and use of responsible investment within the investment industry.

Comparing responsible investment and Islamic finance

Exclusionary screening – including Sharia-screens or UN norms-based screens – is not a requirement of PRI membership but remains a common approach to responsible investment. According to the 2017 PRI reporting dataset, 405 signatories (32%) apply some form of norms-based or negative screening. The dataset further reveals that 235 signatories combine screening with an ESG integration approach, emphasising the complementary nature of exclusionary screens as practiced within Islamic finance and ESG integration. Indeed, there are a range of similarities and differences between Islamic finance and responsible investment.

Similarities

• Strong emphasis on aligning finance with social good
• Seek to increase the contribution of the finance sector to the real economy
• Pursue a more resilient financial system void of unsustainable system risk

Differences

PRI signatories in OIC countries

How the PRI can help

By joining the PRI, you become part of a leading, global network of more than 1,700 signatories, representing over US$68 trillion in AUM. You benefit from an internationally-recognised set of Principles and demonstrate your commitment to responsible investment via an independent link to the United Nations.

The PRI supports its signatories to create a more sustainable financial system through:

• numerous asset class-specific guides, toolkits and case studies;
• opportunities to attend and participate in events and workshops with other signatories, facilitating networking and knowledge-sharing;
• access to the PRI’s Collaboration Platform, a private online resource, which allows signatories to learn, engage and collaborate with companies, policymakers and academics, as well as over 1,700 fellow investors and service providers;
• the PRI’s Academic Network, which offers signatories access to key academic research findings and the opportunity to collaborate with academics;
• the PRI Academy, a CFA-accredited online training system that can be tailored to staff and trustee needs;
• the Reporting Framework, which offers guidance on how communication between corporate plans and beneficiaries can be structured;
• dedicated network managers around the world offering local support.