Launch Partners

Launch Partners

Evolution of Islamic Exchange-traded funds: Opportunities and challenges 

Islamic Exchange-traded funds (ETFs) have emerged as a significant class of financial instruments within the Islamic finance sector. These funds, which comply with Shariah principles, offer investors the opportunity to diversify their portfolios while adhering to Islamic law. This report delves into the evolution of Islamic ETFs, exploring the opportunities they present and the challenges they face. 

Rise of Islamic ETFs 

The concept of Islamic ETFs is relatively new compared to conventional ETFs. The first Islamic ETF was launched in 2007 and since then, the market has seen steady growth. As of 2023, the IFN Investor Fund Database showed there are over 51 Islamic ETFs globally, with assets under management (AuM) exceeding $3.25 billion. This growth can be attributed to increasing demand from Muslim investors seeking Shariah compliant investment options and the broader appeal of ethical investing. 

Key opportunities 

1. Diversification and accessibility 

Islamic ETFs provide a convenient and cost-effective way for investors to gain exposure to a diversified portfolio of Shariah compliant stocks. Unlike traditional mutual funds, ETFs can be traded on stock exchanges, offering greater liquidity and flexibility. 

2. Ethical investing 

The rise of socially responsible investing (SRI) has boosted the appeal of Islamic ETFs. These funds exclude companies involved in activities prohibited under Shariah law –  such as alcohol, gambling and interest-based finance –  aligning well with the values of ethical investors. 

3. Growth in emerging markets 

Many Islamic ETFs focus on emerging markets in the Middle East, Southeast Asia and Africa –  regions with significant Muslim populations. These markets offer robust growth potential, driven by favorable demographics and increasing economic development. 

Challenges facing Islamic ETFs 

1. Limited awareness and understanding 

Despite their benefits, Islamic ETFs remain relatively unknown to many potential investors. Increasing awareness and understanding of these financial instruments is crucial for their growth. 

2. Regulatory and compliance issues 

Ensuring Shariah compliance can be complex and costly. Islamic ETFs must regularly undergo rigorous screening processes to ensure they meet Shariah standards, which can be a barrier to entry for some fund managers. 

3. Market volatility 

Like all ETFs, Islamic ETFs are subject to market volatility. The performance of these funds can be affected by fluctuations in the stock market, economic conditions, and geopolitical events. 

Case study: Hejaz Financial Services 

Hejaz Financial Services, an Australian-based company, launched its Islamic ETFs in 2022 to cater to the growing demand for Shariah compliant investment products in Australia. The five Hejaz Islamic ETF listed on the ASX cover a number of asset classes such as global equities, REITs, Sukuk, companies in high-innovation sectors and high dividend paying companies. Hejaz ETFs will soon be listed on other major exchanges around the world such as LSE, Euronext and more.  

Market data 

According to a report by S&P Dow Jones Indices, the global Islamic finance industry is expected to grow by 10-12% annually over the next few years, with Islamic ETFs playing a significant role in this expansion. The number of Islamic ETFs listed on major stock exchanges has increased by 25% over the past five years. 

Outlook 

The future of Islamic ETFs looks promising, driven by several key trends: 

1. Technological advancements 

Fintech innovations are making it easier to create and manage Islamic ETFs. Blockchain technology, for instance, can enhance transparency through the public ledger and reduce costs associated with ensuring Shariah compliance due to the availability of fund records and the speed of access. 

2. Regulatory support 

Governments and regulatory bodies in countries with significant Muslim populations are increasingly recognizing the importance of Islamic finance. Supportive regulatory frameworks can facilitate the growth of Islamic ETFs. 

3. Integration with ESG investing 

The principles of Islamic finance align well with environmental, social and governance (ESG) criteria. Islamic ETFs that incorporate ESG factors are likely to attract a broader base of socially conscious investors. 

Conclusion 

Islamic ETFs represent a growing segment within the global ETF market, offering unique opportunities for diversification, ethical investing, and exposure to emerging markets. However, challenges such as limited awareness, regulatory complexities, and market volatility need to be addressed to unlock their full potential. As the market evolves, technological advancements and supportive regulatory environments will play a crucial role in shaping the future of Islamic ETFs. 

Muzzammil Dhedhy is Co-Founder, Chief Product & Compliance Officer as well as Executive Director at Hejaz Group

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