Why are Halal ETFs So Expensive?
- Why are Shariah ETFs expensive?
ETFs generally cost under 0.1% in yearly expense fees, with the most popular at just 0.03%. Halal ETFs, on the other hand, cost a minimum of 0.5% — roughly 15 times more, per year. Why is that?
There are three possible contributing factors that explain the relatively high expense ratios charged by Shariah ETFs.
Why are Shariah ETFs expensive?
1. Costly Shariah Screening
The oft-quoted argument is that Shariah ETFs are structured as low-cost funds but still need to undergo costly Shariah screening exercises, in addition to financial leverage screenings to exclude companies with high debt.
However, I’m unsure about the validity of this argument. If the ETF invests in an index (e.g. S&P 500 Sharia Index), in the same proportion as the index — why would they need to undergo the same screening independently, and add to their cost?
Further, why are Shariah screens so costly to begin with? Zoya is an example of an app that provides an AAOIFI compliant assessment of companies (for many more companies than just the S&P500), and on an ongoing basis — for a simple fee of $10/month.
2. Restrictions on Stock Lending
Some funds lend their underlying stocks to borrowers (typically investment banks/brokers) in exchange for a ‘borrowing fee’ (and some cash collateral, to reduce the exposure of the fund ot the borrower).
Since these loans are typically used to support short-selling and hedge fund strategies (largely non Shariah compliant activities), Shariah funds are not able to take advantage of the resulting income.
3. Low Assets Under Management (AUMs)
Shariah compliant ETFs typically have substantially lower assets under management relative to conventional ETFs. Consider that the iShares MSCI USA Islamic UCITS ETF, one of the larger Shariah ETFs, has only $78m under management at the time of publication. The 0.5% expense ratio on a fund with $78m works out to roughly $390k/year in fees. These fees are used to absord all of the fixed and variable costs involved in running the fund (e.g. part time contractor fees, trading fees, filing & legal fees, etc).
Contrast that to VOO, a conventional SP500 fund, that has an AUM of $172 billion. Funds with larger AUMs can afford to charge lower expense ratios — and that could be the primary reason why Shariah ETFs are priced so high in comparison.
While it’s generally cost-prohibitive to construct a portfolio from individual stocks on your own, it is now possible in some countries. In the US, M1 Finance is part of a new breed of apps that allow you to setup your own porfolio, and automatically allocate new investments to match the desired distribution. Essentially, it’s like your own private ETF.
Since the constituents of a given ETF are public one could — albeit, with some effort, construct their own private ETF that mimics a given ETF. While this may still require quarterly monitoring to ensure compliance with the letter of the AAOIFI standard, it may not change often enough to justify the rebalancing effort required.