Governance and Risk in Islamic Investing
June 30, 2018 | Updated at July 23, 2018
Both of us have had careers in finance for much of our adult lives, and that's why we want these blog posts to help you connect ethics with finance and investing; especially Islamic finance.
The attractiveness of an investment can be evaluated by looking at the prospects for return and the degree of risk. An attractive investment is one where the likely returns are high, and the perceived risks are low. When two investments have comparable prospects, but one has less risk, the less risky option is the better choice.
IslamicMarkets.com is about Islamic finance, which has guidance on risk and the nature of investments that are halal. Halal projects tend to be those based on real assets with shared risk and a lack of synthetic financial structures. Even Shariah-compliant investments will still have differing combinations of return and risk.
What can be done to help lower risks and hence make the return prospects more attractive? Given the prior blog posts, you can probably identify the answer: governance. Good governance helps reduce the probability of bad things happening, while also helping to decrease the likely impact of bad things when they do happen.
For companies, good governance means strong relationships with all stakeholders; programs and controls to help maintain those relationships; and, a lot of transparency so that actions inconsistent with good governance can be identified quickly. For countries, good governance means a strong legal, regulatory, financial, and economic infrastructure where disputes can be adjudicated in an objective manner, along with a high degree of transparency and honesty to avoid, or at least minimize, corruption.
Companies with good governance have tended to have stronger shareholder returns. At a country level, the stock markets of countries with good governance have also tended to have stronger returns. There is also increasing evidence that companies and countries with good governance tend to have a better environmental track record and greater social justice.
For Islamic investing, the implications of good governance are important. Shariah compliance removes haram. That step should be the starting point for Islamic investing, but not the end of investment considerations. Islam encourages good governance. Selecting investments based on governance is consistent with Islamic guidance and makes the world a better place, while also providing the opportunity for superior returns.
As we have in prior posts, we will end with what each of us can do. The most important task is to encourage good governance at all levels. Participate in democratic processes and encourage candidates who will strengthen governance. Choose to work for companies with better governance and help your company improve its governance. These actions are also likely to improve your career opportunities. Good governance extends beyond companies and countries. It includes religious organizations, social organizations, charities, and schools. These actions to strengthen governance help to build strong foundations and start virtuous cycles.
Improving governance makes it easier to be relevant, with trust being established more quickly, while impact can occur on a larger scale. In addition to #RTI, these actions can help improve investment returns and also lower risk.
Kurt and Daud