The SP Funds S&P 500 Sharia Industries Exclusions ETF (NYSEARCA:SPUS) aims to provide diversified exposure to U.S. equities screened for compliance with Islamic religious law. This means that the fund excludes companies operating in various business activities prohibited within the principles of Halal investments.
SPUS has come to our attention based on its impressive performance. With an inception date in late 2019, SPUS has managed to beat out the S&P 500 Index (SP500), including this year where the fund has returned more than 25%.
Our explanation for the spread comes down to the fund’s unique factor tilt of the fund, which has essentially been overweight some of the strongest sectors while systematically avoiding lagging industries over the period.
While that dynamic may not continue indefinitely, the takeaway is that SPUS performs as intended. In our view, SPUS is a good option for Muslim investors as a core holding in the context of a broader diversified portfolio.
What is the SPUS ETF?
SPUS is part of a growing segment in the market catering to socially responsible or values-conscious investing. In this case, SPUS focuses on specific religious guidelines that have been formalized by the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI).
While most people will be aware that Islam prohibits the consumption of alcohol, pork products, or the participation in gambling activities; Sharia law extends further. Companies screened out through investment methodology include non-compliant income sources derived from interest-based businesses, credit cards, media broadcasting, and the defense industry.
Another unique aspect of Sharia Law is that prohibits investing in firms that are highly leveraged. Here, the threshold used is a debt-to-equity ratio of 30%. This criteria adds a layer of quality to the fund by limiting exposure to stocks that may be fundamentally challenged with poor financials across any industry.
Overall, the takeaway is that Sharia Law investments have a distinct mandate compared to other types of value-conscious strategies like environmental, social, and governance (ESG) themed funds, for example. The good news here is that the strategy has worked.
Starting with the universe of S&P 500 companies, SPUS ultimately narrows that universe of stocks down to 204 current holdings. The fund is rebalanced and reconstituted monthly, with weightings based on the float-adjusted market capitalization. There is also a monthly dividend that currently yields 1.0%.
Going through the current positions, Apple Inc (AAPL), Microsoft Corp (MSFT), and NVIDIA Corp (NVDA) are the three largest holdings in SPUS. That being said, what stands out is not so much the stocks included, but more so the names that don’t meet Sharia compliance.
Notably, Amazon.com, Inc (AMZN) is notably absent from SPUS holdings. Other high-profile names excluded from SPUS are The Walt Disney Co (DIS), Netflix, Inc (NFLX), Anheuser-Busch InBev SA/NV (BUD), RTX Corp (RTX), Carnival Cruise Line (CCL), and all financial services firms.
By excluding more than half the stocks in the traditional S&P 500, the result is a higher concentration at the top, with the mega-cap leaders gaining incremental importance within the fund’s performance, at the expense of the smaller names.
The top-10 holdings in SPUS represent nearly half the fund at a 49% weighting, compared to 31% in the SPDR S&P 500 Trust (SPY).
At the sector level, the key differences with the Sharia portfolio become more apparent. The fund’s allocation to the technology sector at 43% is well above the 28% in SPY. Similarly, given the prohibition of interest-bearing, SPUS allocation to the Financial sector is at zero. This covered not only banks, but also credit card issuers, and insurance firms.
SPUS also does not hold any utility sector stocks based on their typically leveraged capital structure. On the other hand, sectors like energy, and materials capture a modest overweighting exposure.
Overall, the portfolio represents a significant deviation from the standard S&P 500 and helps explain the fund’s relative performance.
We already mentioned that SPUS has outperformed SPY, breaking out with a convincing lead in 2023. There are several factors at play here. First, it has helped that SPUS is overweight some of the biggest stock market winners this year in technology relative to the S&P 500.
Stocks like NVDA, TSLA, and META have more than doubled this year and SPUS benefited from that additional exposure. The rise of artificial intelligence has been a major market theme this year, with SPUS finding itself well-positioned to capture that exposure, whether intentionally or not.
It has also paid this year to avoid the more volatile and underperforming Financials sector. Going back to the banking industry turmoil in Q1 with the failure of several institutions like SVB Financial (OTCPK:SIVBQ) and First Republic Bank (OTCPK:FRCB), which were previously S&P 500 constituents, SPUS sidestepped this performance drag.
In terms of the utility sector, this group has been the worst-performing in the S&P 500 this year, largely pressured by rising interest rates. The understanding is that most utility sector stocks among regulated electrical power companies carry significant debt and fail the Sharia compliance screening process.
What’s Next For SPUS
It’s clear to us that the circumstances in the market over the past couple of years have favored the Sharia Industries Exclusions strategy. At the same time, it is fair to assume that during a different market cycle where technology stocks underperform or financial lead higher, the fund could face some renewed volatility and lag the benchmark S&P 500.
In terms of the outlook over the next year, major macro themes including questions regarding the strength of the global economy and the next steps in Central Bank policy will likely dictate the pace of equity returns. We expect SPUS to perform well relative to other equity benchmarks.
Within the constraints of Sharia law, investors need to consider alternative types of diversification. On this point, SP Funds offers the SP Funds S&P Global REIT Sharia ETF (SPRE) which takes the Islamic investing theme by focusing on the real estate sector. There is also the SP Funds Dow Jones Global Sukuk ETF (SPSK), which holds an alternative to bonds known as “Sukuk” which are asset-backed instruments offering regular distributions that do not involve interest.
We sense that practicing Muslim investors would need to incorporate the full range of Sharia-compliant investment vehicles in addition to alternative investment vehicles for a more complete type of diversification to achieve long-term risk and return objectives. There is also the Wahed FTSE USA Sharia ETF (HLAL) and the Wahed Dow Jones Islamic World ETF (UMMA) as options investors can consider in this market segment.
Our opinion is that SPUS is a good benchmark among Sharia-compliant U.S. equity funds, with a performance record that speaks for itself. While I am not personally Muslim, I have an open mind and am encouraged to see the ever-evolving landscape of ETFs meeting the needs of all types of investors.
In terms of risks, we mentioned that the unique constraints of the strategy pose some challenges to diversification in the traditional sense. The fund would also be exposed to a broader macro slowdown, which could generate a round of financial market volatility, pressuring stock prices lower.