I have been researching/screening stocks for a few years now. However I have been confused for quite some time as to why some screening methods (including FTSE/MSCI) include all debt for the debt:ratio calculation, while others (including the guide on IFG and S&P) only include interest-bearing debt.
Could you please shed some light on the wisdom/thought process behind this difference? This interesting article (‘Debt is debt, even if it is shariah compliant’) argues that we should not be reliant on debt and that allowing for shariah compliant debt can mean that companies in Muslim majority countries can simply shift interest bearing debt to shariah compliant debt in order to keep its position on a shariah index- surely this defeats the purpose?
JzkAllahkher Mufti for sharing this. This does explain the 30% screening criteria, however it doesn’t make the case for separating shariah compliant and non-shariah compliant debt.
First of all, I believe the author of this article made somewhat a lose assumption when he says " The rationale for a 33% threshold is to weed out firms with too much leverage"
I believe the 33% in this case is to minimise interest base debt only, and not debt in general, and Allah knows best.
Debt is debt, but debt with interest payment is not acceptable in shariah, therefore they both cannot be compared. However, the author seems to have an issue with all debt from a financial/economic perspective rather than a fiqh perspective. For that, he may have a point, but I am not a financial analyst or expert, so I cannot express an opinion on this point.
Thirdly, you said that MSCI shariah screening have a total debt ratio as criteria. i do not think this is the case. In the methodology research paper released in 2011 it says: “Sharia compliant debt and Sharia compliant instruments will be excluded from total debt when calculating the ratio of total debt over total assets and from the numerator when calculating the ratio of cash and interest‐bearing securities over total assets, respectively. This will be applied to the following countries: Gulf Cooperation Council (GCC) Countries ex Saudi”
We can see from the above that they are making a distinction between shariah compliant and non compliant debt.
I believe it is the same with FTSE shariah index. And if for argument sake, they dod not make the distinction, then most likely it is based on financial rather than a fiqh perspective.
Barak’Allahu feek for this in-depth explanation and for expanding on this. I have previously seen the MSCI methodology research paper and did note that shariah compliant debt would be excluded, however I was unsure as it noted it would be applied to Muslim majority countries only- so thank you for clarifying this.
I think the main point I was seeking was the purpose of the 33% debt ratio, and you have made this clear (that its purpose is to minimise interest based debt only), so I thank you again.