Indices are basically measuring sticks for different segments of the market.
ETFs are groupings of stocks that trade like individual stocks.
Many ETFs are designed to track the performance of indices.
One of the cheapest ETFs tracking the S&P 500 is the Vanguard S&P 500 ETF (VOO).
If you look at the VOO ETF and compare it to the S&P 500, you’ll notice the blue line representing VOO ETF and the red line representing the S&P 500 are basically identical. This is of course by design as the VOO ETF is designed to mirror the performance of the S&P.
Since ETFs that track a particular index will basically have the same return as the index itself, it is important that investors consider the expense ratios of different ETFs.
For Muslim investors concerned with only investing in halal stocks, indexes have emerged that claim to only track halal stocks and in turn ETFs have emerged that track these indexes.
One of the halal indexes that has emerged is something called the FTSE Shariah USA Index.
FTSE Shariah USA Index
As for the Business Activity Screening, I agree with the broad categories of screening mentioned.
However, one shortcoming of simply screening companies by their general business activity or the industry they are in is that some companies that don’t pass the common sense test slip through the cracks. So for example no consideration is given to how a company is affecting the environment or how it treats its employees or whether or not it has relationships with suspect parties. All of which in my opinion will affect a company’s halalness rating.
When discussing halal investing, I think there is too much focus on coming up with definitive formulas for determining whether a company is halal or haram and not enough importance is placed on human judgement and common sense.
Regarding the financial ratios screening, I pointed out why these screens have basically no merit as per the Quran and Sunnah in an earlier video “How to Pick Halal Stocks”. Briefly, my arguments against these financial criteria are:
Financial Screen # 1: Debt is less than 33.33% of total assets:
My commentary: Debt is not prohibited in Islam, interest is prohibited. So it’s not accurate to say that there is any limit on the amount of debt a company can have.
Financial Screen # 2: Cash and interest-bearing items must be less than 33.3% of assets:
My commentary: It is certainly not haram to hold cash in any percentage of total assets. I can start a business with nothing but cash as an asset on its books and it would be completely halal for you to buy any portion of it for any price we agree to. This is because the most important asset for any company never shows up in formal accounting and that asset is the company’s human capital.
Financial Screen # 3: Accounts receivable and cash are less than 50% of total assets.
My commentary: There is no basis in the Quran or sunnah for any limit on cash or accounts receivable.
Financial Screen # 4: Total interest and non-compliant activities do not constitute more than 5% of companies activities.
My commentary: Noteworthy here is that this 5% number is a made up number. Although I certainly don’t think it’s an unreasonable rule of thumb. However, it is important to realize that it is rather difficult to ascertain for companies with multiple billions of dollars in revenue what exactly is coming from a halal source vs. what isn’t. If you claim to have precisely calculated the number, you are probably wrong.
For example, Apple doesn’t make money from podcasts directly. However, in order to listen to a podcast through their app you need an Apple device. So if you really wanted to use Apple Podcast you’d have to buy one of their devices. So how much of Apple’s revenue comes from podcasts? Certainly not zero or else why would it offer them? Further, what percentage of Apple’s podcasts would be considered halal content vs. haram?
Further still, what percentage of the Music that Apple sells is haram?
You can see how complex any attempt at calculating Apple’s halal income with precision can quickly become.
My personal rule of thumb is to ask myself whether I can describe the income from non-halal sources the company earns as trivial or not.
If I can’t or I’m not sure then I don’t invest.
However, just because I think they’ve missed the mark with their financial screens doesn’t mean the companies the index contains are not halal.
The superfluous financial screens will only serve to shrink the pool of eligible companies but won’t necessarily add companies that aren’t halal.
Wahed’s ETF Ticker Symbol (HLAL)
HLAL is meant to track the FTSE Shariah USA Index.
The HLAL ETF has 221 companies in it.
The top 15 holdings represent around 50% of the funds holdings.
These holdings are weighted based on their respective market caps.
I quickly went through their 221 holdings.
The majority I would have no problem investing in from a halalness perspective.
Lulu Lemon (LULU) is one company they have in their portfolio that I wouldn’t necessarily be comfortable investing in. Their flagship product is their yoga pants which are rather revealing and certainly not something a Muslim can wear in public.
News Corp (NWS) is another company in their portfolio which I wouldn’t feel comfortable investing in because of its strong association with news outlets that I find to be hostile towards Muslims.
There is a judgement call that needs to be made here and my judgement may differ from yours.
Also, I would be remiss not to mention that the two companies I mentioned only weigh ~0.5% of the overall portfolio.
HLAL has less than 1-year of performance data which is not enough to draw high-confidence conclusions.
Since inception of the HLAL ETF on July 16th 2019 and up until June 1st 2020, the HLAL ETF has had a return of 5.00% compared with 3.61% for VOO, an ETF that is tracking the S&P.
After HLAL’s expense ratio of 0.5% compared to VOO’s expense ratio of .03%, HLAL had a net return of 4.50% compared with 3.58% for the S&P tracking VOO.
So a difference of 1% between the two in HLAL’s favor.
Keep in mind this result will differ based on the date you choose to make your comparison.
If I chose April 1st 2020 instead of June 1st 2020, the difference would be -15.32% return after fees for VOO compared to -17% for HLAL.
i.e. 1.5% in VOO’s favor.
Again, just 1 year of performance data isn’t really enough to draw conclusions.
Two additional points I think I should point out about HLAL:
They are overweight Apple stock. It consists of 16% of the portfolio compared with 4.43% for the next heaviest position which is Johnson & Johnson.
For VOO their biggest position is Microsoft which is ~5% of their holdings.
So the fortunes of HLAL and whether or not it is above or below the market will largely depend on Apple’s performance.
The second point is their management fee.
According to their site the expense ratio for HLAL is 0.5%
The expense ratio is the annual cost paid to fund managers by holders of ETFs.
So if the expense ratio is .5% and the fund returns 5% then 10% of the profit goes to the fund.
For passive index funds, the typical expense ratio is about 0.2%.
While I personally don’t invest in ETFs because I’ve been able to outperform them, Investors who are not that familiar with the financial markets and don’t want to bother with picking individual stocks might be well-served to invest in an exchange traded fund that tracks the broader market.
HLAL has done this reasonably well while maintaining a portfolio that avoids the obviously haram stocks.
Areas for improvement for HLAL include lowering their expense ratio and improving their screening for halal stocks.
This is not investment advice. Don’t invest money you can’t afford to lose and don’t put all your eggs in one basket.
If you’re investing a large amount of money you probably want to have it distributed among different asset classes rather than having it all in stocks.
This is because assets within the same asset class tend to be correlated. Recall that between February and March of 2020 almost all stocks lost at least 30%-40% of their value.
One asset class which you should consider if you earn more than 200K annually is BFF’s income share agreements which have exhibited 0 correlation with the overall market.