MohammedAmin.comSerious writing for
serious readers
The issues of concentration risk and cash drag in mutual funds are as relevant with Shariah compliant investing as they are with conventional investing.
Posted 22 February 2025
Having written recently about the general principles of equity investing and about what is available in the UK, for my April 2024 column in the magazine "Islamic Finance News" I decided to look briefly at the USA.
While I looked at four specific investments, the main purpose of my article was to further explain some basic principles such as concentration risk, and the cash drag that often arises with open-ended mutual funds.
You can read it below.
My 6 December 2023 column set out some general principles about long-term Shariah compliant equity investing. After my 3 January 2024 column looked at some of the choices available in the UK, I wanted to build on the previous articles by looking at what is available in the USA.
There too many funds for me to cover comprehensively, but as with the UK looking at just a few brings out some general principles. I began with a couple of mutual funds managed by Saturna Capital www.saturna.com
|
Amana Income Fund |
Amana Growth Fund |
Established |
1986 |
1994 |
Assets under management |
$ 1.8 billion |
$ 5.1 billion |
Cash and equivalents % |
7.3% |
3.5% |
Largest holding |
Eli Lilly |
Apple |
Largest holding as % of fund value |
13.6% |
7.1% |
Annual fund operating expenses, Investor Shares (what individuals buy) |
1.02% |
0.91% |
Both are actively managed funds.
I have some concerns about concentration risk in the Amana Income Fund with 13.6% of the fund in Eli Lilly, a company which represents only 1.4% of the S&P 500 index.
Concentration is not automatically bad (Warren Buffet has done very well by it) but investors should think about the issue before investing. Conversely the Amana Growth Fund’s 7.1% in Apple is only slightly over its 5.7% weight in the S&P 500.
The Amana Income Fund has a surprisingly high 7.3% held in cash. In the long run cash holdings are a drag on investment performance.
Mutual funds typically hold cash balances either to accommodate redemptions or because investor inflows have resulted in cash not yet invested. Conversely neither factor impacts exchange traded funds (ETFs) due to the mechanism for creation and redemption of ETF units by institutional market participants.
I also looked at just a couple of ETFs.
|
Wahed FTSE USA Shariah ETF |
SP Funds S&P 500 Sharia Industry Exclusions ETF |
Established |
2019 |
2019 |
Index description |
The Index is composed of common stocks of large and mid-capitalization US companies the characteristics of which meet the requirements of the Shariah and are consistent with Islamic principles as interpreted by subject-matter experts. |
The Index is composed of the constituents of the S&P 500 Shariah Index other than those from the following sub-industries:
|
Fund size |
$ 393 million |
$ 460 million |
Largest holding |
Microsoft |
Microsoft |
Largest holding as % of fund value |
14.6% |
12.6% |
Net expense ratio |
0.50% |
0.45% |
The largest holding represents an even greater percentage of the fund than with the actively managed ETFs. However, in this case it arises from Microsoft’s weight in the US stock market, amplified by excluding non-Shariah compliant companies.
In conventional equity investing, those wanting an ETF but concerned by concentration risk can choose ETFs that track equal weighted indexes instead of market capitalisation weighted indexes. However, a quick search did not find any equal weighted Shariah compliant indexes.
Advertisement
Finally, I have deliberately said nothing about the historic performance of these investment funds. Historic performance is a really poor way of selecting investment funds, even though most investors are guilty of making investment decisions on that basis.
I strongly recommend reading “The Intelligent Fund Investor: Practical Steps for Better Results in Active and Passive Funds” by Joe Wiggins, and following his blog Behavioural Investment at https://behaviouralinvestment.com
Mohammed Amin is an Islamic finance consultant and former tax partner at PwC in the UK.
