Shariah-compliant Portfolio Management Process

A Shariah-compliant portfolio is one that comprises only approved Islamic savings and investment assets that comply with Shariah law and Islamic practices. Such a portfolio would pass the Shariah-compliance evaluation benchmarks or thresholds set by an authorised Shariah screening committee.

Shorn of their regulatory details, the thresholds to keep in mind are:

• 5% where a secondary business activity is related to alcohol, gambling, gaming or non-halal categories,
• 20% where revenues or rentals accrue from share trading, stockbroking or Shariah non-compliant activities, and
• 33% for a company's debt over total assets ratio.

There is much more detail, of course, to these benchmarks but what is worthy of highlight here is how the legal and regulatory frameworks of Shariah-compliance help to maintain the purity of the practices and activities of Muslims.

Shariah portfolio management deviates only a little from conventional portfolio management. In general, a Shariah portfolio is considered less volatile in nature than a conventional portfolio. This allows the investor to stay reassured with only passive or occasional portfolio management. However, there are two key points that merit the investor's consideration and portfolio management skills.

The first of these points relates to the change in the status of stocks from Shariah-compliant to Shariah non-compliant, and vice versa. This often happens when a Shariah-compliant company has decided to venture into a business activity or sphere that is not Shariah-compliant or, alternatively, a Shariah non-compliant company has found a way to ensure Shariah-compliance in its business activity.

The status review is usually done by the Shariah Advisory Council (SAC) of that publishes updates of its classification lists of securities twice every year, in May and November. Similarly, the Islamic indices are reviewed in June and December.

If you are self-managing your portfolio, you would want to refer to these lists as soon as they are published to do your rebalancing. This is crucial as the Securities Commission says that investors must dispose products whose status has changed to Shariah non-compliant. If, however, investors choose to maintain the Shariah non-compliant funds, any dividend received must be donated to charity. Another option is to purchase a different Shariah-compliant product instead. If disposing the non-compliant funds brings you a loss instead of returns, you have the right to have the company bear the loss and ensure that your funds are restored.

The second point is about periodic monitoring. Data shows that Islamic finance products outperform conventional funds in an economic downturn. This stability results from the socially responsible investing (SRI) principle of selecting only companies that pass the Shariah screening benchmark

However, in times when the economy is booming, conventional funds do have the potential to outperform Islamic funds and gain better reward traction. This tells us that, depending on the economic situation, you might consider switching your portfolio's weightage between Islamic and conventional funds periodically or consider leveraging on the Modern Portfolio Theory (MPT), whereby having different asset types of different economic backgrounds helps balance out losses and gains in a single portfolio. This counters market risk and volatility and helps your portfolio stay afloat and profitable.

As you monitor your portfolio, it is important to keep an eye out for new Islamic financial products that might offer a better reward with lower risk or lower fees. Exploring the different types of funds available in the Islamic market will allow you to diversify and create a customised portfolio that suits your risk appetite at a certain time.

Based on your investment preferences, you can choose from Islamic banking and takaful or the Islamic capital market, with options from sukuk to unit trust funds. A constant revaluation of the funds in your portfolio will help you get better at maximising returns and minimizing risk. To ensure your goals are achieved, you would need to set a few parameters, like your risk-reward ratio, expected returns, acceptable maximums and minimums for losses and gains, and the amount you must allocate for hidden fees.

If your current asset mix does not meet your reward-goals or warrants a change due to market volatility, quick action will help you avoid any capital loss. It is also important to perform a self-assessment on the type of investor you are and your tolerance for risk.

For example, if you are looking for exponential growth in a short timeframe for your current capital, you know that you must include investments like i-Stocks which have the potential for a quicker jump in rewards. However, you need to be comfortable with the market dictum that high returns come with a higher risk of complete capital loss. If you cannot accept the accompanying risk, you need to be sure about what your risk-comfort level is before deciding what assets to add and hold to achieve your goals.