iShares ETF (ISUS) Review | Practical Islamic Finance

In this article, we’ll provide an in-depth iShares ETF (ISUS) review, offered by BlackRock. First established on the London Stock Exchange (LSE) in 2007, this ETF currently has $174+ million in assets under management (AUM). The fund provides direct exposure to large and mid-cap U.S. companies and claims to adhere to Shariah investment principles. By the end of this article, you will have a clear understanding of the ISUS/ISDU ETF and will be equipped to assess whether it’s a worthwhile investment fund for your needs.

About iShares by BlackRock

iShares is a subsidiary of BlackRock, the world’s largest asset management company, and is responsible for issuing and marketing iShares products. iShares is a global leader in Exchange Traded Funds (ETFs) with a line-up of over 1,250 ETFs.

iShares MSCI Islamic UCITS ETF Overview

Investment Objective

The investment objective of the ISUS/ISDU fund is to offer investors a comprehensive return that encompasses both capital gains and income, mirroring the performance of the MSCI USA Islamic Index.

Investment Strategies and Style

According to the fund’s propectus (see page 62), to meet its investment objective of mirroring the MSCI USA Islamic Index, the ISUS/ISDU mutual fund invests in a portfolio of securities that claims to align with Shariah principles. The MSCI USA Islamic Index is designed to measure the performance of large- and mid-capitalization stocks in the U.S. equity market that comply with Islamic investment principles.

The base currency for the iShares MSCI USA Islamic UCITS ETF is the US Dollar. The Fund’s exchange, ticker, currency, and listing dates are detailed in the table below:

The Fund’s registered locations include Bahrain, Belgium, France, Germany, Ireland, Italy, Luxembourg, Netherlands, Portugal, Singapore, Spain, Switzerland, United Arab Emirates, and the United Kingdom.

The Fund’s strategy involves replicating the composition of the Benchmark Index by holding its component securities in similar proportions to their weightings in the Index. The Index is weighted by market capitalization and undergoes quarterly rebalancing.

To effectively gain exposure to the components in the MSCI USA Islamic Index, the Fund may occasionally invest in convertible investment-grade sukuk (Shari’ah-compliant bonds), ADRs (American Depositary Receipts), GDRs (Global Depositary Receipts), and GDNs (Global Depositary Notes).

ADRs are negotiable certificates issued by U.S. banks, representing a specified number of shares in a foreign stock that is traded on a U.S. exchange. GDRs are similar to ADRs but are issued by international banks and are traded on multiple global exchanges. GDNs are debt instruments that represent ownership of a specific number of shares of stock; they can be traded globally but are not listed on a stock exchange.

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

Shariah Compliance

The ISUS/ISDU fund appears to adhere to Shariah compliance through layered oversight. A specialized Shariah Panel, appointed by iShares, ensures the fund aligns with Islamic law. It issues rulings and compliance advice. Separately, the MSCI Shariah Board reviews the Benchmark Indices quarterly for compliance and updates.

The Shariah Panel can also explore alternative investment methods like ADRs and GDRs for compliance but does not manage the fund. It issues an annual Shariah compliance certificate and resolves conflicts of interest among its members. Key panel members include Dr. Mohamed Elgari, Sheikh Nizam Yaquby, and Dr. Mohammed Daud Bakar.

The methodology framework by the MSCI USA Islamic Index (which the ISUS/ISDU ETF tracks) is also worth mentioning. It filters out companies with more than 5% revenue from activities like alcohol or gambling. It should be noted that PIF recently adopted a 2.5% limit. It also screens for excessive debt and income from interest using three financial ratios: 1) total debt/total assets; 2) cash and interest-bearing securities/total assets; and 3) accounts receivables and cash/total assets. These ratios must not exceed 33.33%. A dividend adjustment factor is applied for any non-compliant income.

In summary, the Shariah compliance of ISUS/ISDU hinges largely on the expertise of its Shariah board and the implementation of standard financial filters, specifically concerning debt, interest, cash, and accounts receivable. These measures typically exclude stocks that are clearly haram, while favoring those with lower financial leverage. However, this methodology may neglect other important ethical considerations, such as environmental stewardship and employee welfare. Moreover, the financial ratios employed may not be entirely consistent with Islamic teachings. For a more robust halal stock selection, we advocate the integration of human judgment into the stock picking process.

Performance

ISUS/ISDU’s performance has beaten the market (aka the S&P 500 Index) over the 1-year and 3-year periods on an average annualized basis, but has failed to do so over the more pertinent 5-year and 10-year periods. This is shown in the table below:

iShares: Average annual total returns. Performance data is based on the net asset value (NAV) of the ETF which may not be the same as the market price of the ETF, and does not include the fund’s expense ratio. Month-end Performance, as of September 30, 2023.

While not the official benchmark for ISUS/ISDU, the comparison to the S&P 500 Index is relevant because it aligns with the fund’s objectives and concentrates on large/mid-cap U.S. stocks. This relationship is further depicted in the chart below, which is shown over the 5-year period:

TradingView: ISUS/ISDU vs. SPY. Prices shown are total returns (not including the expense ratio) over the 5-year period.

Although ISUS/ISDU has not outperformed the market over extended periods, which are more consequential than short-term results, the fund seems to closely track its benchmark index—fulfilling the primary objective of this ETF.

However, it’s crucial to evaluate the fund’s annualized average return of 7.17% since its inception in December 2007, a figure that precedes the deduction of the fund’s 0.30% expense ratio and excludes adjustments for inflation and taxes. This data point is instrumental in evaluating the fund’s long-term ability to generate above-average realized returns. This is particularly notable when compared to the S&P 500 Index, which typically yields an average annualized return that is approximately 3% higher, or around 10%.

Further, the fund’s stronger performance over the past three years appears to be largely attributed to its heavy concentration in its top two stock holdings (as discussed below). This may not be a reliable indicator for long-term sustainability.

Efficiency

Understanding ETF efficiency is essential as it impacts potential returns and the success of the ETF in achieving its investment objectives. Below is a table presenting key metrics that provide insight into the efficiency of ISUS/ISDU:

iShares | As of 10/19/2023

While data on the fund’s tracking error or tax gains rate is not readily available, it’s important to highlight that the fund has an expense ratio of 0.30%. Though not exceptionally attractive, or justified by the fund’s performance, in isolation this is more favorable than its U.S. halal ETF counterparts like HLAL and SPUS, which carry expense ratios of approximately 0.50%.

Tradability

Tradability is a critical factor in an ETF, affecting an investor’s ability to buy or sell positions at advantageous prices. A highly tradable ETF ensures liquidity, minimizes bid-ask spreads, and lowers trading costs. Below is a table that outlines key metrics indicative of ISUS/ISDU’s tradability:

iShares | As of 10/19/2023

Information on the tradability of ISUS/ISDU is limited. Therefore, it is strongly recommended to place a buy limit order at the fund’s Net Asset Value (NAV) when making a purchase. This ensures that you pay no more than the actual worth of the basket of securities, and possibly less.

Portfolio

ISUS/ISDU’s portfolio consists of ~136 holdings, with ~54% of assets in its top holdings, which is relatively top-heavy. According to Morningstar, 136 holdings are in holdings are primarily in large-cap (some mid-cap) equity investments (99.86% U.S. equities, 0.0% non-U.S. equities), with the other holding being cash (the remaining 4 holdings or 0.14%).

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

iShares ISUS/ISDU ETF: Top 10 Holdings (as of October 19, 2023)

The performance of Microsoft, and to a lesser extent, Tesla, accounts for ~30% of both the returns and implied volatility in ISUS/ISDU’s portfolio. This indicates a significant level of concentration, which should be considered a risk factor for investors in this fund.

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

iShares ISUS/ISDU ETF: Sector Allocations (as of October 19, 2023)

Building on our earlier note about concentration, it’s consistent that the fund is also heavily weighted in the technology sector. Interestingly, the fund has greater exposure to the energy sector compared to other halal-focused ETFs or mutual funds targeting large-cap U.S. growth equities. Given that the energy sector is generally sensitive to market fluctuations and tends to exhibit slower growth, this could be viewed more as a risk factor than a benefit.

In summary, should the technology market face unfavorable conditions, investors can anticipate that this ETF may experience a larger downside deviation compared to a more diversified market-tracking ETF.

Portfolio Fit

Assessing portfolio fit is essential when considering an ETF, as it helps to ensure that the investment aligns with an investor’s financial goals and risk tolerance. A well-fitted ETF can contribute to a balanced and diversified portfolio, supporting the broader investment strategy while potentially mitigating risks. Key metrics that indicate ISUS/ISDU’s suitability for portfolio inclusion are presented in the table below:

iShares | As of 10/19/2023

The table above highlights that both ISUS/ISDU and the MSCI USA Islamic Index (its benchmark) have 136 holdings, which likely explains the fund’s ability to track its index so well.

Portfolio Metrics

Below are key metrics commonly employed for a more precise assessment of risk-adjusted performance:

iShares | As of 10/19/2023

The fund’s 3-year beta of 0.997 suggests that ISUS/ISDU closely mirrors market movements, while a standard deviation of 17.23% indicates moderate volatility. Unfortunately, data on alpha, R-squared, and the Sharpe ratio are not available. These metrics would offer a more comprehensive view of the fund’s risk-adjusted performance.

Conclusion

In summary, the iShares MSCI USA Islamic UCITS ETF (ISUS/ISDU) presents itself as a Shariah-compliant investment option targeting large and mid-cap U.S. equities. The fund has shown strength in short-term performance, yet has not outperformed the market consistently over more extended periods. Among its merits are a competitive expense ratio of 0.30% and an apparent close tracking of its benchmark index, the MSCI USA Islamic Index.

However, prospective investors should exercise caution for several reasons. The fund demonstrates a significant concentration in the technology and energy sectors, which could expose it to sector-specific risks. Moreover, its top two holdings, Microsoft and Tesla, constitute more than a quarter of the fund’s market value, and are likely the driving forces behind the fund’s returns and volatility thus far. Information regarding the fund’s efficiency, tradability, and other key portfolio metrics are also not readily available, presenting an incomplete picture for those seeking to invest with full knowledge of all risk factors. Given these considerations, it is difficult to recommend ISUS/ISDU as a worthwhile long-term investment.