Sharia index tracker versus global (ethical) equity in workplace pension (USS)

FIREmenow

Hi Everyone,

Just looking to get some thoughts on the merits of different funds when there is a limited choice within a workplace pension, particularly Sharia versus ethical funds.  I am referring to the DC part of the USS hybrid pension scheme, but aiming to understand all of these funds, and their pros and cons. For context, I am happy to be 100% equities as I have the DB part of the pension also accruing and am at least 20 years from (early) retirement.

I hope this might also help others in the USS, because I have done some digging to find this information, which is still incomplete.

In USS, there are five pure equity funds you can choose to invest in through the 'Let Me Do It' option - a global equity, an ethical global equity, an emerging markets equity, a UK equity, plus a Sharia fund.  (There are also funds that mix equity and bonds, bond funds, liquidity funds, and ethical versions of these, but they are not all available for DIYers).  All funds were launched in 2016.  Where a fund invests in more than one underlying fund, the percentages of each are not given by USS (as far as I can see). I've put a summary of each fund and it's performance lower down this post which I've dug out of the USS website.

Essentially I am looking for thoughts on how people a Sharia top 100 large cap index tracker with minimal tracking error compares to an actively managed ethical equity fund, that has been underperforming it's benchmark for the last five years.  More details below.

My DC pot is 100% invested in the ethical equity fund, which has two underlying funds, and is trying and failing to beat the market. its performance pa since launch is on par with the benchmark, but it has underperformed considerably in annualised performance over the last 2, 3 and 5 years, last year being 2.5% against 11.5% benchmark.  For me it's not ideal that the ethical fund is the one that has the most active tinkering going on, evening though it has outperformed everything but the Sharia fund pa since launch.

With ethical equity, the threadneedle fund is actively managed, 80% in shares and "may also invest in other transferable securities, other collective investment schemes (which may include schemes managed by the ACD), money market instruments, warrants, cash and near cash. The Fund may use derivatives for the purposes of efficient portfolio management only."  I think this is invested in about 50 companies from my attempt to understand their financial statements and is about 35% tech. I can't find details of how contributions are split between the two underlying funds, presumably the other fund is passive, as they describe the overarching fund as a mix of active and passive.  It's also not clear whether the split between the two funds is fixed or can also be actively altered.  The other fund is called LGIM Ethical Climate Aware Equity, and the closest thing I can find on the LGIM website is Ethical Global Equity Index Fund, which tracks the FTSE 4Good Developed Index to which they take a 'pragmatic' approach - but I've no idea how similar that would be to the one USS uses.

I'm looking at the Sharia fund as an alternative for new money, but I think that might be too aggressive so might need some diversification. I'm trying not to just make this decision based on the Sharia line going higher in the performance graphs than all the others!  The ethical component is somewhat important to me, which seems to have some overlap with Sharia principles.  The underlying fund is HSBC Islamic Global Equity Index, which tracks DJ Islamic Market Titans 100 Index.  Following Sharia investment principles, the HSBC tracker follows the top 100 global large caps, excluding finance, entertainment, alcohol, tobacco, pork-related products, and weapons and defence sectors, with some financial ratio exclusions.  The index is heavily tech currently, as you would expect - 46%, and has about 4% gas and oil (which I want to keep low).  It aims to track the index as tightly as possible.

My sense is that this is a bullish and undiverse to me, and it might be wise not to put all my eggs in this basket going forward.  My monthly contributions are about 6% of my current pot per month, so if I put 100% of new money in the Sharia fund going forward, it could quickly dwarf my ethical equity holding.

Appreciate people's thoughts on how to best weigh up the pros and cons of all these different elements when comparing a limited number of options in a workplace pension.  I'm trying to take more interest, but USS doesn't make it easy!

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More detail on each fund, if anyone is intersted!

The descriptions below of aims and management type are theirs, not mine.

From the 2023 Q4 investment report:

-The UK Equity tracks the benchmark passively. Benchmark is FTSE Custom All-Share ESG Screened Index. It is made up of Blackrock Aquila Connect UK Equity.  Since launch it's performance per annum has been 4.5% against 5.2% benchmark. Five-year annualised fund volatility is 14.3%.

-The global equity tracks the benchmark and includes emerging markets (8%), is not currency hedged, and is passively managed.  The benchmark is Solactive USS Developed Markets Climate Transition Benchmark (92.00%), MSCI Emerging Markets Index (8.00%).  It is made up of LGIM Climate Tilted Global Developed Markets Equity (not a collective pooled fund) and Blackrock Aquila Connect Emerging Markets. Since launch it's performance pa is 9.9% against 9.7% benchmark. Five-year annualised fund volatility is 13.3%.

-The emerging markets fund aims to produce a return better than the benchmark, is not currency hedged and is "predominantly passively managed with a degree of active management". Benchmark is MSCI Emerging Markets Index. It is made up of Blackrock Aquila Connect Emerging Markets, Baillie Gifford Emerging Markets Growth, and USSIM Global Emerging Markets (not a collective pooled fund).  Since launch it's performance per annum has been 4.9% against 4.4% benchmark. Fire-year annualised fund volatility is 16.6%.

-The ethical global equity fund aims to produce a return better than the benchmark, is not currency hedged and is "a mix of passive and active management". Benchmark is MSCI World Index. It is made up of LGIM Ethical Climate Aware Equity Global (not a CPF) and Columbia Threadneedle Responsible Global Equity. Since launch it's performance per annum has been 10.5% against 10.5% benchmark (it has underperformed at 1, 3 and 5 years pa. The last year was 2.5% against 11.5% benchmark which they attribute to the manager overweighting weak performing consumer discretionary stocks). Fire-year annualised fund volatility is 14.4%.

-The Sharia fund aims to rise and fall with the benchmark investing in shares which meet Islamic investment principles, is not currency hedged, it is passively invested into a single tracker fund.  The benchmark is DJ Islamic Market Titans 100 Index.  It is made up of just HSBC Islamic Global Equity Index, which tracks the benchmark index. Since launch it's performance pa is 13.7% against 13.8% benchmark. Five-year annualised fund volatility is 14.7%.

Here is the 5-year cumulative performance of DIY funds:

Hard to see, but red, green, and light blue/grey lines are Sharia, ethical equity, and global equity respectively:

gm0

My observation would be that the global ethical equity fund (which I also use a version of though not via USS. Performs quite similarly in the end to the standard global equity fund.  The slight balance change (missing sin stocks replaced probably with a shade more US and meg cap unit per unit - have created a gap in the line - for a while.

I have kept a holding in a version of it and it was my best performing fund in 2023. And has been a low cost global equities play for me for some years.  Is it the best.  No.  Is it the worst. Also no.  If the price is right (which it is for me) it's not a terrible option but it looks like you can hold global equities without the obscure index.  We didn't have that opportunity.

LGIM promise the return of the passive index FTSE4Good to within a margin of error.  And the fund largely does that.  Whether the list of stocks in that index appeals to you is the key fact.  All the pension specials are tiny facade funds built over the bigger LGIM fund management universe.  So the size of a pension special is less relevant than for a retail fund.

The Threadneedle active fund of fund stuff resold by LGIM is way way more actively managed. And if you like that .  Great.  Or you don't.  I don't. When I want an active fund for a specific need then I want that specific fund matching need without the fund of fund overlay and so with a much simpler mandate.  

It's not Threadneedle I don't like or trust. It's that entire business model.  Though if I was shopping for such a thing I probably would shop direct in my SIPP not via the LGIM reseller angle.

BlackKnightMonty

I can see some strong similarities with the UK NEST pension fund which offers a range of cautious to higher risk fund options.

You can only choose one fund. The best performing fund to date is the Sharia fund. It’s similar to yours in that it is less diversified and tech heavy.

It’s the fund I have chosen for my NEST and it is performing extraordinary well. (The fund went up 2.7% on Friday). No doubt tech is looking bubbly. But even with ups and downs I know that it is the best choice for me.

You can see a link to the latest report below. 27.2% growth over the last 12 months!

https://app.powerbi.com/view?r=eyJrIjoiODVlYjQ1YjItYzI0NS00OGM1LTkzYTMtNmUwM2U2MTg2OTZjIiwidCI6IjBhNzJmMDMyLTFkMDktNDU3ZS1iYTAyLWU1NjU2OTU0ODZjZiJ9

ussdave

Really interesting discussion.  I don't have much to add if I'm honest - I think the little investment and fund knowledge I have has already been surpassed

The Sharia fund is an interesting one.  I don't use it personally but the performance of course is enticing.  The overweight in tech stocks is one mark against but though I do like some of the exclusions (e.g. gambling, other areas that are dubious from an ethical standpoint), I don't really like the religious angle (e.g. excluding pork, etc).  I suppose I should really be looking to move to the ethical growth fund.  Just have a bit of inertia about that as I don't feel well informed enough and I've not put aside enough time to rectify that.

JohnWinder

A lot of nice background there; not always easy choices.

The theory, with not much to counter it, based on the efficient market hypothesis, capital asset pricing model and later variants, suggest that your best 'return for risk' will come from the most diverse capitalisation weighted index fund tracking a reasonable index at low cost. And, you'll never have to say sorry to yourself for choosing unwisely. Small deviations from that wouldn't be worth fussing over, but take large variations and you really have to start thinking about your choices: why do this; can I ignore all the evidence suggesting passive is better than active; size of impact; alternatives; conviction to see it through to the end.

'trying not to just make this decision based on the Sharia line going higher in the performance graphs than all the others! '

I hope you've succeeded, because to use higher returns for a short period to compare similar type funds would do yourself a grave disservice if it suggests the future would be the same. Compared to a benchmark, go right ahead. And compared to a benchmark year by year, not matching its benchmark every 5 years, unless you can wait 5 years to get at your money and the 5 years is a reliable figure.

FIREmenow

gm0 said:

LGIM promise the return of the passive index FTSE4Good to within a margin of error.  And the fund largely does that.  Whether the list of stocks in that index appeals to you is the key fact.  All the pension specials are tiny facade funds built over the bigger LGIM fund management universe.  So the size of a pension special is less relevant than for a retail fund.

The Threadneedle active fund of fund stuff resold by LGIM is way way more actively managed. And if you like that .  Great.  Or you don't.  I don't. When I want an active fund for a specific need then I want that specific fund matching need without the fund of fund overlay and so with a much simpler mandate.  

Thanks for your thoughts gm0, the active management is also what I don't like. I'm annoyed that I would need to foregoing an ethical holding and potentially go back to general global equity to avoid it and still be fairly diversified.

BlackKnightMonty said:

I can see some strong similarities with the UK NEST pension fund which offers a range of cautious to higher risk fund options.

You can only choose one fund. The best performing fund to date is the Sharia fund. It’s similar to yours in that it is less diversified and tech heavy.
You can see a link to the latest report below. 27.2% growth over the last 12 months!

https://app.powerbi.com/view?r=eyJrIjoiODVlYjQ1YjItYzI0NS00OGM1LTkzYTMtNmUwM2U2MTg2OTZjIiwidCI6IjBhNzJmMDMyLTFkMDktNDU3ZS1iYTAyLWU1NjU2OTU0ODZjZiJ9

Thanks BlackNightMonty, had a look at the report and it is in fact the exact same underlying Sharia fund with HSBC!

I noticed that Nest have 32 underlying funds etc, of which only four are passively managed.

ussdave said:

Really interesting discussion.  I don't have much to add if I'm honest - I think the little investment and fund knowledge I have has already been surpassed

The Sharia fund is an interesting one.  I don't use it personally but the performance of course is enticing.  The overweight in tech stocks is one mark against but though I do like some of the exclusions (e.g. gambling, other areas that are dubious from an ethical standpoint), I don't really like the religious angle (e.g. excluding pork, etc).  I suppose I should really be looking to move to the ethical growth fund.  Just have a bit of inertia about that as I don't feel well informed enough and I've not put aside enough time to rectify that.

Thanks ussdave, I appreciate your honesty - have learned a lot from your USS posts!
Being vegetarian, the exclusion of pork is a step in the right direction in terms of ESG for me, and another plus-point in terms of being an alternative to ethical equity.

JohnWinder said:

A lot of nice background there; not always easy choices.

The theory, with not much to counter it, based on the efficient market hypothesis, capital asset pricing model and later variants, suggest that your best 'return for risk' will come from the most diverse capitalisation weighted index fund tracking a reasonable index at low cost. And, you'll never have to say sorry to yourself for choosing unwisely. Small deviations from that wouldn't be worth fussing over, but take large variations and you really have to start thinking about your choices: why do this; can I ignore all the evidence suggesting passive is better than active; size of impact; alternatives; conviction to see it through to the end.

'trying not to just make this decision based on the Sharia line going higher in the performance graphs than all the others! '

I hope you've succeeded, because to use higher returns for a short period to compare similar type funds would do yourself a grave disservice if it suggests the future would be the same. Compared to a benchmark, go right ahead. And compared to a benchmark year by year, not matching its benchmark every 5 years, unless you can wait 5 years to get at your money and the 5 years is a reliable figure.

Thanks JohnWinder, that lack of diverse capitalisation weighting is what bothers me about the Sharia fund, and the evidence of passive being better in the long run than active management is what bothers me about the Threadneedle fund that underlies the ethical equity. USS subsidised the full cost of fees at the moment, and I presume they get an institutional discount (?) but I also noted that the Threadneedle active fund fee was near to 1%, the Sharia fee is not as high but certainly not low-cost which makes sense with the process that happens to confirm which stocks meet Islamic principles.

Against their benchmarks, the Shariah fund is within 0.1 of the benchmark across all time frames they quote, annualised.
The ethical equity fund has been.
Since launch - 10.5%, benchmark 10.5%
Last 5 years - 7.7%, benchmark 8.9%
Last 3 years - 4.4%, benchmark 10.2%
Last year - 2.5%, benchmark 11.5%
So it's really not doing a good job of beating the market.

We don't have to pick just one in USS, and I can choose a percentage of new money to go into various funds. I'm thinking that introducing a small percentage of the Sharia fund and keeping an eye on the ethical equity fund's performance against its benchmark might make sense. There should be another quarterly report soon. USS also state that the underlying funds are subject to change at any time, so will need to keep an eye on the quarterly reports for changes anyway.

Does anyone know, if I wanted to find out the long term performance of a fund like the Sharia one, would this be similar to the S&P Global 100? Or does this data exist for the DJ Islamic Market Titans 100 Index? As in, how long the typical recovery is after a drop etc over different eg. 40-year time periods going back as far as there is data. (I know this modelling has a name but I can't remember it!) Would be good to see in terms of how risky it is in a pension that is at least 20 years away from being accessed, near to 30 years until SPA.

Many thanks again for all your thoughts.

BlackKnightMonty

You can get longer term projections on the NEST Sharia Fund here;

https://markets.ft.com/data/funds/tearsheet/holdings?s=GB00BFZNFH05:GBP

and here:

https://www.trustnet.com/factsheets/p/klls/nest-sharia-pn

ussdave

FIREmenow said:

ussdave said:

Really interesting discussion.  I don't have much to add if I'm honest - I think the little investment and fund knowledge I have has already been surpassed

The Sharia fund is an interesting one.  I don't use it personally but the performance of course is enticing.  The overweight in tech stocks is one mark against but though I do like some of the exclusions (e.g. gambling, other areas that are dubious from an ethical standpoint), I don't really like the religious angle (e.g. excluding pork, etc).  I suppose I should really be looking to move to the ethical growth fund.  Just have a bit of inertia about that as I don't feel well informed enough and I've not put aside enough time to rectify that.

Thanks ussdave, I appreciate your honesty - have learned a lot from your USS posts!
Being vegetarian, the exclusion of pork is a step in the right direction in terms of ESG for me, and another plus-point in terms of being an alternative to ethical equity.

Despite being a meat eater myself I think I'd be quite happy to (perhaps slightly hypocritically) invest in a fund that included meat-free investments.  I'm just not a fan of the reasoning behind the choice in this case (for clarity - that's not a view against any one particular religion).

I can see your point regarding the outcome being a step in the right direction though

Anyhow, I'll let you get back to the main topic of the thread.  I'll continue to read with interest.

Cornish_mum

Hi All,

I just wanted to flag this notice from USS about using inflation plus 3% as their reference benchmark for the general DC growth fund https://www.uss.co.uk/how-we-invest/our-investment-performance Does anyone know what the benchmark they are using for Ethical equity? 

Also naïve question but aren’t all ESG funds active (ie funds are chosen on the basis of research regarding the nature of the companies business)? 

Also has anyone worked out how to get the “ethical” diversified additional investments ie strategic infrastructure etc within the “let me do it”option I can only seem to choose that on the do it for me option. 

Thanks 

CM

JohnWinder

;Also naïve question but aren’t all ESG funds active (ie funds are chosen on the basis of research regarding the nature of the companies business)? ;

The reason we might say ESG trackers are not active funds is because the fund manager has no discretion (in reality a tiny bit) about which securities the fund holds. She must hold what is in the index if she hopes to track it closely, which is the goal and standard by which her performance should be judged by investors. 

This effectively transfers the active part of the investing, ie deciding which business is ESG, from the fund manager to the index maker. So you're right, ESG trackers become active funds in that sense. So why might that be acceptable to folk who don't like active funds?

It's because index providers make public, in detail, how they decide on the composition of their index. It's transparent, so investors can know exactly what they're getting themselves in for.  It's also because the performance of the index over many years can be compared with the performance of another index, so investors can see how different the two were and might be in future.You don't get those benefits with actively managed ESG funds because the managers like to keep secret their recipes for stock selection. That's what it means to add manager risk to all the other risks you take when you invest in actively managed funds; the manager risk might turn out to be good for you or bad for you compared to no manager risk. That's the risk.

Lastly, going ESG moves you away from a market cap weighted holding, the latter being the best return for risk portfolio you can have, theoretically. But it many not alter the returns very much, just as many other variations from the market cap weighted portfolio such as omitting the very small companies or omitting under-developing countries might not. Indeed you might get better returns (for a while) by being deviated from a market cap weighted holding eg by holding only large US companies in recent years, but also consider whether this is due to extra risk.

FIREmenow

Hi CM,
All of the growth funds are now aiming for CPI+ different percentages, rather than a benchmark.  The benchmark for the Ethical equity is MSCI World Index, which is not an ESG index. There's a bit of info on how the ethical equity works at the bottom of my first post.

There are ESG indexes, which a tracker fund can track passively. This would be similar to the Sharia fund, which tracks a specifically Sharia index and is benchmarked against that same index. No idea why USS are using a non-ESG index to benchmark the ESG fund's performance. One of the funds underlying the ethical equity does track an ESG index - the FTSE 4Good Developed Index but the other is totally actively managed.

I'm not sure which one you mean that has strategic infrastructure, but the ethical equity is the only ethical fund you can get in Let Me Do It. There is a PMG Core Infrastructure fund that is one of the 20 underlying funds that are packaged into the (non-ethical) growth funds, that would be the only way to access that, but USS don't make it clear what percentage of each of the 20 funds is held, just what split they aim for between asset classes.

The other pre-packaged ethical options are only in the Do It For Me, and having clicked through the steps almost to the end, it seems you can't just switch between the two with new money to try and diversify - you have to instruct it to sell all your DIY investments and start again with all the money in Do It For Me.

Hope that helps a bit, some of it's clear as mud on the website.