Shariah investments set a track record by passing the worst economic crisis

As we move further into 2009 and the ninth quarter since the start of the credit crisis, has the story of Shariah investing changed? Our report, Shariah Investing: Challenged by Commodities, highlighted how the third quarter 2008 saw Shariah indices struggle with cyclical downturns and a rally in the financial sector. A reasonable expectation for the end of the first quarter of 2009 would have been that the Shariah indices underperformed the conventional as the broad market picked up and financials rallied again. However, the Dow Jones Islamic Developed World Index (DJIDWI), is still outperforming the MSCI World as of the end of April 2009 and in fact, the gap between the two has widened since the beginning of the year. Two quarters of going nowhere? After the rally that started at the end of November 2008, equity markets returned to their downward trend into the New Year. After a short boost of confidence, investors again worried about the health of the financial system and showed their concern about further deterioration of companies' earnings and forward outlooks. The DJIDWI posted negative returns in January and February 2009 as was the story for the MSCI World Index. However, with financials once again at the centre of investor concerns, the DJ Islamic Indexes, which do not have meaningful exposure to financials, outperformed their MSCI counterpart indices through the first two months of 2009, as has been the case over a majority of the last nine quarters of the credit crisis. Through March and April 2009 markets once more started to show signs of recovery and April, in particular, saw the financial sector benefiting from a flurry of major banks reporting better-than-expected earnings. Financials led the way but all sectors of the MSCI World Index were up in April. Stocks related to the financial crisis rebounded from their lows and, as such, the DJ Islamic Indexes underperformed against the MSCI World Index for the month. The assumption that Shariah performance is inversely correlated to the financial stocks recovery appeared both fair and correct in April 2009. However, like the MSCI World, all sectors of the Dow Jones Islamic Index posted positive gains for the month. In fact, the losses the MSCI World made in the first two months and the gains in the second two months did nothing more than bring the index back to where it was at the start of 2009. The MSCI fell more than the DJIDWI in January and February and did not recover strongly enough, regardless of market conditions, to surpass the less volatile Shariah Index. It has been, in effect, a start to the year that has seen the markets go nowhere and the DJIDWI remained the stronger index at the close of Q1 2009. New year. New story? We may have started 2009 with hopes of the markets stabilising. However, volatility remains high. As a result, we do not anticipate seeing the story of Shariah investing outperformance shifting to one of underperformance just yet. Islamic investors should continue to benefit from their lack of exposure to the volatile financial sector and erratic market swings. The favouring of low-debt companies should continue as a positive quality. Burnt by the implosion of highly leveraged companies, we might also see conventional investors gravitate to those companies with sound underlying fundamentals and valuations. However, looking forward, we do expect that Shariah will begin to loose its trend of strong outperformance eventually. The alpha that has been built over the credit crisis will begin to give way as conventional markets and financials, in particular, move into recovery. We believe the gap between the two indices is likely to narrow and return to the pattern they followed up until April 2007. The interesting question if this convergence of performance happens, will it really matter and will it harm the perception of Shariah investing? The perception that Shariah-compliant investing is a poorer cousin to conventional has been challenged, as Shariah investing has delivered a good track record in difficult times with outperformance and lower volatility. These nine troubled quarters have shown that Shariah investors do not need to put ethical or religious beliefs second to investment performance expectations. Shariah investing has passed its first major test in one of the worst economic episodes and it is not unfair to expect that it will perhaps do so again in the boom and bust cycles typical to a debt related economy. - The author is the Senior Executive Officer of SEI Investments for the Middle East Keep up with the latest business news from the region with the daily Emirates Business 24|7 newsletter. To subscribe to the newsletter, please click here .