Azzad Ethical Fund (ADJEX) Review | Practical Islamic Finance

In this article, we’ll provide an in-depth review of the Azzad Ethical Fund (ADJEX), offered by Azzad Asset Management. Established in the U.S. in 2000, this mutual fund currently manages $124+ million in assets under management (AUM). It stands out as the sole mid-cap U.S. equities growth mutual fund tailored specifically for Muslim investors. By the end of this article, you will gain a clear understanding of the Azzad Ethical Fund (ADJEX) and be able to determine whether it is a worthwhile mutual fund investment for your needs.

About Azzad Asset Management

Azzad Asset Management, founded in 1997, is a registered investment advisory firm located near Washington, D.C., specializing in ethical investing. They offer various financial services including college funds, retirement accounts, and living trusts.

Azzad is a member of the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI), the Forum for Sustainable and Responsible Investment (US SIF), and the Interfaith Center on Corporate Responsibility (ICCR).

Azzad Ethical Fund (ADJEX) Overview

Investment Objective

The goal of Azzad Ethical Fund (ADJEX) is to deliver long-term total returns to its shareholders through methods aligned with the Adviser’s ethical principles. The fund trades on the NASDAQ exchange under the ticker symbol ADJEX.

Investment Strategies and Style

The Ethical Fund’s goal is to earn returns from both dividends and an increase in the value of its investments. To do this, it primarily invests in stocks of medium-sized companies that show promise for high growth and quality. These companies are similar in size to those in the Russell Midcap Growth Index, which, as of September 30, 2022, had companies valued between $304 million and $47.30 billion. However, company sizes in this index can change over time.

A company named Delaware Investments Fund Advisers (DIFA) helps guide the investment decisions for the Ethical Fund. They offer a model and suggest which stocks to buy, hold, or sell. But, the final decision on when and what to invest in, especially keeping in line with ethical standards, is up to the Ethical Fund’s Adviser.

DIFA’s stock picks come from in-depth research on individual companies. They look for firms with potential for solid growth, consistent revenues, and good overall financial health. They also consider bigger economic factors like interest rates and inflation.

If a company no longer looks promising or doesn’t meet the Fund’s ethical standards, the Adviser might decide to sell that investment. They might also sell to take profits, avoid bigger losses, or invest in newer opportunities. Lastly, to capitalize on market opportunities, the Ethical Fund may buy and sell investments frequently, leading to higher turnover. Bottom line, this is all fairly standard for any mutual fund.

For further details on which accounts, brokerages, and/or countries the ADJEX mutual fund can be accessed, see their literature or contact their team.

Shariah Compliance

Azzad Asset Management adheres to Shariah compliance through a three-tiered governance structure mandated by the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI). This includes an internal Shariah auditor, a three-member Shariah advisory board, and annual independent verification. They follow AAOIFI rules, screening out investments in companies profiting from certain prohibited sectors. Their compliance is further ensured through a proprietary screening tool named Islamic Screening and Filtering Application (ISFA), which scrutinizes every potential investment for Shariah compliance​.

Additionally, the Azzad Ethical Fund abstains from investing in corporations earning significant revenue (over 5%) from sectors like alcohol, tobacco, pornography, pork, gambling, hydraulic fracturing, private prisons, or weapons, as well as from securities or instruments generating revenue from interest, preferred stocks, convertible securities, futures contracts, debt trading, or trading the same kind of monetary instruments.

It’s notable that the firm employs a three-tiered governance structure and a unique ISFA screening tool for Shariah compliance. Regardless, while the Shariah filters standardly exclude haram stocks and favor less leveraged ones, this approach may not be exhaustive. Relying solely on industry-based screening could miss key ethical aspects like environmental or employee welfare. Furthermore, the financial criteria on debt and cash holdings may not be firmly grounded in Islamic teachings. A more nuanced approach, integrating human judgement, is instead what we advocate for when selecting halal stocks.

Fund Fees and Investment Minimums

Fund Fees

The annual fund operating expense ratio for ADJEX are broken down in the table below:

As stated in the Fund’s most recent Prospectus dated November 01, 2022.

The expense ratio of 0.99% is not ideal, and on the higher end, as actively managed funds typically range between 0.50% – 1.0%.

It’s also worth mentioning the stipulation to the fund’s current 0.99% expense ratio, beyond what is explained in the table above. According to the fund’s prospectus, if the Ethical Fund’s future expenses drop below the limit of 0.99% of its average daily net assets (for instance, they decline to 0.90%), the advisor has the right to “take back” fees equivalent to the -0.13% they initially waived. However, there are strict conditions:

• Time Limitation: The adviser can only recoup these fees within a three-year window from when they were originally waived.
• Expense Ceiling: The recoupment cannot push the expenses above the set limit (0.99%) or any other future limits determined by the board.

For investors, this potential recoupment may raise concerns. The fund would argue that these stipulations act as safeguards, ensuring the risk is well-controlled. While the expense ratio might see minor fluctuations due to this -0.13% adjustment, it’s capped by the set limits. Regardless, recognizing this mechanism is important, as it introduces slight variations in the fund’s operating expenses. Though not a major risk, it’s an operational detail informed investors should be aware of.

Now, to illustrate the impact of this expense ratio, let’s say you start with an initial investment of $100,000 in ADJEX, and assume a 10% average annual return. The results after 10 years are shown below:

• Future Value after 10 years (including fund fees): $236,953.65
• Total Fees Paid: $22,420.60

Now, let’s compare this to an alternative fund with a 0.50% expense ratio (the norm for the most comparable halal ETF alternatives), assuming the same 10% annual return:

• Future Value after 10 years (including fund fees): $247,822.76
• Total Fees Paid: $11,551.37

The difference in fees paid over these 10 years is $10,869.11. This difference, albeit not monumental, can compound significantly over longer terms or with larger investments, underscoring the importance of fee considerations in long-term investment strategies.

Thus, it’s crucial to assess Azzad Ethical Fund’s fees-adjusted performance over time and whether it offers compelling value compared to a more affordable halal ETF alternative with a similar growth-centric equities emphasis (albeit, not focused on mid caps).

Investment Minimums

According to Azzad Ethical Fund’s propsectus, the minimum to open a regular account is $1,000. However, to open an IRA account or to open a Coverdell account, the minimum is only $500. If you want to add additional capital to your account, in all cases the minimum is $50. Overall, this adds a slight barrier to entry, particularly for novice investors.

Performance

The performance-to-date of Azzad Ethical Fund has been underwhelming, exhibiting persistent underperformance when compared to the market (aka the S&P 500 Index), and its closer peers among mid-cap U.S. equities growth funds.

This is shown in the table below:

Morningstar: Average annual total returns, load-adjusted. Month-end Performance, as of September 30, 2023

Note that the returns in the table above provide a picture of the fund’s “load-adjusted return” performance, which includes the fund’s expense ratio.

However, this calculation is missing the impact of taxes on the fund’s trades.

Morningstar reports the 3-year tax cost ratio for the fund is 1.40%. This means, that on average each year over the last 3 years, investors lost 1.40% of their assets in the fund to taxes. Despite falling below Morningstar’s category average of 1.99%, the fund should not be considered as a tax-efficient mutual fund. This is particularly noticeable when compared to a halal ETF alternative, which wouldn’t entail such a loss.

The more accurate tax-adjusted returns are shown in the table below:

Morningstar: Tax-adjusted average annual total returns, load-adjusted. Month-end Performance, as of September 30, 2023

For a more accurate comparison, given that the S&P 500 Index isn’t primarily comprised of mid cap U.S. equities, it’s more pertinent to measure ADJEX’s performance against similar funds (the Category) and the Morningstar Mid Cap Broad Growth Index. The latter serves as a more fitting benchmark that ADJEX should surpass to qualify as a worthwhile investment.

As illustrated by the table, and previously mentioned, ADJEX has notably lagged behind the Category and Index across the 15-year, 10-year, 5-year, and 3-year periods, although it surpassed the market in the last year. This assessment is based on an average annualized performance, post adjustments for taxes and fees.

When evaluating performance, it’s also worth examining the portfolio’s yield. Currently, ADJEX has a yield of 0.53% (derived from dividends of portfolio holdings). For context, this trails the category average and index (at 0.82% and 1.19% respectively, as per Morningstar), marking it lower than similar funds and adding to the downsides of investing in this fund.

Evidently, while ADJEX facilitates Muslims in accessing halal mid cap growth stocks in the U.S., its 15-year performance history hardly makes it a recommendable investment. It’s crucial to acknowledge that past performance doesn’t assure future returns, yet ADJEX has historically struggled to outperform the market, even disregarding taxes. This track record, arguably, reflects on the fund manager’s capabilities.

Portfolio

Azzad Ethical Fund has 68 holdings in its portfolio, with ~27% of assets in its top 10 holdings, which is not very top-heavy. 67 holdings are in equities (94.07% U.S. equities, 2.49% non-U.S. equities), with the other holding being cash (the remaining 3.45%).

The table below breaks down the fund’s top 10 holdings:

Azzad Ethical Fund: Top 10 Holdings (as of June 30, 2023)

The table below breaks down the fund’s sector allocations:

Azzad Ethical Fund: Sector Allocations (as of August 31, 2023)

As you can see, the fund is relatively concentrated within technology and health care, which is typical of halal growth-oriented funds.

Turnover Rate

The fund’s reported portfolio turnover on Morningstar is 27.88%, which is moderate, and may explain the fund’s below Category average 3-year tax ratio of 1.40% (vs. 1.99%, as discussed prior). Even so, the 27.88% portfolio turnover means that over a quarter of the fund’s portfolio has been replaced over the past 12 months, which could be a sign of management competency.

Portfolio Metrics

The key portfolio metrics investors can use to evaluate the risk-adjusted performance for funds are shown below for ADJEX:

Morningstar: Fund Statistics and Explanations (as of September 30, 2023). *N/A = Not applicable.

The table above shows that while ADJEX’s beta is 0.03 higher than the category average, indicating slightly more volatility, it fares better in other metrics relative to its category. However, the critical indicators, alpha (-7.40) and R-Squared (83.47), significantly highlight its underperformance. The negative alpha highlights its struggle to meet its benchmark. The R-Squared value reflects that although most of the underperformance is explained by overall market movements, at least ~17% is explained by individual stock/sector selections. These statistics accentuate that ADJEX lacks the market-beating potential typically sought in actively traded funds.

Fund Managers

The four fund managers and their backgrounds are summarized below:

• Jamal Elbarmil: Vice President at Azzad Asset Management since April 2000, formerly portfolio manager of Ethical Fund (2008-2017) and Wise Fund since inception, oversees daily fund management, holds a master’s in Information Systems from American University, and has 21 years of investment experience.
• Kimberly A. Scott: Senior Vice President and Portfolio Manager at DIFA since 2021, prior roles include investment analyst and portfolio manager at Ivy Investment Management Company, holds a BS in Microbiology, an MBA from University of Cincinnati, and is a CFA Charterholder.
• Nathan A. Brown: Senior Vice President and Portfolio Manager at DIFA since 2021, previously investment analyst and assistant portfolio manager at Ivy Investment Management Company, holds a BBA in Finance and an MBA with a focus on Finance and Accounting from Vanderbilt University.
• Bradley P. Halverson: Managing Director and Senior Vice President at DIFA since April 2021, formerly investment analyst and portfolio manager at Ivy Investment Management Company, holds BS and MS degrees in Accounting from Brigham Young University and an MBA with a focus on Finance and Corporate Strategy from University of Michigan.

While Jamal Elbarmil’s steady leadership since Azzad Ethical Fund’s inception in 2000 denotes stability and commitment, the fund’s performance remains the definitive yardstick. Bottom line, is that the long-term underperformance against its benchmark and the market is concerning.

Notably, Morningstar states that aside from Jamal, Kimberly, Nathan, and Bradley assumed their portfolio manager roles only around 2021/2022, a brief tenure to-date given the fund’s inception on December 22, 2000. Though Jamal’s enduring leadership is praiseworthy, the paramount goal is robust investment returns, which have been lacking.

Conclusion

In conclusion, Azzad Ethical Fund (ADJEX) presents itself as an option for ethical investors seeking to align their principles with their investments and gain exposure to U.S. mid cap growth stocks. However, the fund’s performance history, high expense ratio of 0.99%, and notable tax costs indicate that it may not provide the compelling value one might expect.

Put simply, ADJEX’s persistent underperformance compared to its benchmark and peers casts doubts on its ability to provide competitive returns. While the fund’s commitment to ethical principles is commendable, investors should carefully weigh its historical performance against their financial goals and risk tolerance before considering an investment. Our recommendation leans towards caution regarding ADJEX as an investment choice.