Half of Islamic fund managers report investor interest in ESG and many of them now have sustainable Islamic funds

• A recent CIBAFI survey found that almost one-third of Islamic fund managers offered sustainable Islamic funds
• Fund managers’ offerings of sustainable Islamic funds were in response to investor demand, and almost half said they had received some interest in ESG
• The steady growth of Islamic funds incorporating ESG highlights the importance of RFI Foundation’s quantitative research study, which offered clues about how fund managers can get the most out of the combination of ESG and Shariah screening

A focus on environmental, social and governance issues is increasingly popular among Islamic funds, although as only a minority of Islamic fund managers reported in a recent survey by CIBAFI that they had integrated ESG into their investment, it seems likely this will grow. In the survey, which was heavily weighted towards the Middle East and North Africa, with fewer than 5% of responses from Southeast Asia, where there have been a flurry of ESG and Shariah-compliant fund announcements recently, 29% of fund managers and Islamic banks surveyed said they offered sustainable Islamic funds.

Although the CIBAFI survey did not report on the total assets under management of those offering sustainable Islamic funds, if the share of respondents was representative of the total AUM factoring in ESG issues, then the growth of ESG perceptions in the Islamic funds sector has broadly followed the growth outlined in a report released in 2015 by the RFI Foundation and Refinitiv (formerly Thomson Reuters).

In that forecast, RFI forecast the unmet latent demand for ESG across 12 Islamic markets between 2015 and 2019 based on growth of ESG funds globally, and in relation to the Islamic funds market growth prospects at the time. The main difference with the recent growth was an underestimate of the growth of the Islamic funds market, where assets under management have tripled since 2015, reaching $194.5 billion by the end of 2021.

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The survey conducted by CIBAFI showed a steady growth of ESG integration by Islamic funds managers in line with fund managers’ perceptions around the demand for responsible investment in their markets. Of those surveyed, 28% said they saw demand for ESG to a great or substantial extent. Another 16% saw moderate demand, at a time when interest has grown rapidly in many Islamic markets. The survey results suggest nearly half of Islamic fund managers have seen an uptick in demand from investors for ESG.

There is good reason for this growth given the increased attention that the financial materiality of social and environmental issues, including climate change, has seen since the start of the Covid-19 pandemic. Research from RFI Foundation and INCEIF, released recently, found strong evidence that positive ESG characteristics was associated with better performance in emerging markets.

In emerging markets, RFI’s research found that portfolios of better ESG-scoring companies were associated with better performance, including for Shariah-compliant subsets. These markets have the best opportunities for Islamic fund managers to distinguish themselves from competitors through their ESG integration.

The overlay within emerging markets of ESG best-in-class on Islamic funds can be done with more of a straight overlay, notwithstanding the limitations around ESG data within many emerging markets. In developed markets-focused funds, there is still an opportunity to be had from combining ESG and Shariah screening in comparison to doing only one or the other, but it requires greater nuance than in a straight overlay of best-in-class ESG on an Islamic fund.

What the RFI Foundation’s research indicated for developed markets is that some of the performance benefit from the best ESG-scoring portfolios may be priced into stock prices. In developed markets, then, there is more to be lost by ignoring ESG than to be gained by adding it. Shariah screens can help extract this value, especially in portfolios holding lower-scoring ESG companies, where the Shariah-screening process acts as a ‘margin of safety’ by removing over-indebted companies from the universe.

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