Written by Muhit Masood
As values-based investing gains traction worldwide, two investment vehicles have emerged as increasingly popular among ethically conscious investors: Shariah compliant ETFs and Green ETFs. While both offer alternatives to traditional, profit-maximization-only strategies, they operate on distinctly different principles.
This article explores the key differences between these two exchange traded fund categories, comparing their foundations, screening methods, and investment objectives to help investors navigate the growing landscape of ethical and impact-driven investing.
1. Foundational Principles
Shariah Compliant ETFs:
These ETFs are governed by Islamic finance principles derived from Shariah law. The goal is to provide investment returns while remaining compliant with Islamic ethical and legal standards. These funds avoid interest-bearing instruments (riba), excessive uncertainty (gharar), and haram (prohibited) industries such as alcohol, gambling, and conventional finance.
Green ETFs:
Green ETFs are rooted in environmental sustainability. These funds primarily invest in companies or projects focused on environmentally friendly practices – such as renewable energy, carbon reduction, sustainable agriculture, and green technology. Their mandate is to support environmental outcomes and contribute to fighting climate change.
2. Screening Criteria
Shariah Compliant ETFs:
Screening involves both qualitative and quantitative filters:
- Qualitative: Exclude companies involved in prohibited sectors (e.g., alcohol, tobacco, pork, weapons, adult entertainment, and conventional banking or insurance).
- Quantitative: Financial ratios must meet Shariah thresholds – for instance, total debt to assets or market value; or interest-bearing securities should remain below a specified percentage.
Oversight is typically provided by a Shariah advisory board, ensuring ongoing compliance.
Green ETFs:
Screening is based on Environmental, Social, and Governance (ESG) criteria, often with a focus on the “E”:
- Companies are evaluated for their carbon footprint, energy use, pollution, climate risk management, and sustainability initiatives.
- Funds may track specific indices like the MSCI Global Green Bond Index or S&P Green Bond Index, and third-party ESG ratings are commonly used for filtering.
Oversight is typically provided by ESG analysts, index providers, and sustainability committees.
3. Investment Universe
Shariah-Compliant ETFs:
These ETFs generally have a more limited universe due to strict compliance rules. For example, financial institutions, which form a significant portion of most global indices, are excluded. This leads to a greater concentration in sectors like technology, healthcare, and industrials – especially in U.S. markets.
Generally, about 50% of stocks listed on global markets qualify as Shariah compliant.
Green ETFs:
Green ETFs also have a narrowed universe but in a different way. Their focus is on sectors actively contributing to environmental sustainability. This often includes clean energy, electric vehicles, water infrastructure, and green real estate. Fossil fuels and high emissions industries are excluded.
4. Objectives and Impact
Shariah Compliant ETFs:
The main objective is religious and ethical alignment. While most Shariah ETFs heavily intersect with ESG principles (e.g., avoiding debt heavy or unethical firms), the goal is spiritual compliance and halal income generation, not necessarily environmental or social activism, an objective which is more or less achieved as well.
Green ETFs:
The objective is environmental impact. These funds aim to contribute directly or indirectly to combating climate change, promoting clean technology, and encouraging corporate sustainability. Profit is still a goal, but secondary to the environmental mission.
5. Performance and Risk Considerations
Shariah-Compliant ETFs:
Performance may differ from conventional ETFs due to sector exclusions and limited diversification. For example, excluding interest-based financial institutions can impact exposure to high-dividend stocks. However, Shariah compliant ETFs have performed competitively in tech-heavy sectors.
Green ETFs:
Performance is influenced by the broader ESG and green economy trends. While they can be volatile – especially in sectors like clean tech – they benefit from increasing policy support, regulatory incentives, and growing consumer demand for sustainability.
Conclusion
While both Shariah compliant ETFs and Green ETFs fall under the umbrella of ethical or responsible investing, they serve distinct purposes and attract different investor profiles.
- Shariah-compliant ETFs are ideal for investors seeking halal income aligned with Islamic values, focusing on both moral and financial purity.
- Green ETFs cater to environmentally conscious investors looking to align their portfolios with sustainability goals and climate action.
For some investors, these two paths may overlap. In fact, a growing number of Shariah ESG hybrid funds are emerging, offering the best of both worlds – faith-based financial discipline combined with environmental stewardship.
As values based investing continues to expand, understanding the nuances between these ETF types is key to building a portfolio that truly reflects your personal beliefs and long-term goals.
