What to Know About Faith-Based Investing

Faith-based investing has long been a niche corner of the fund industry, but that may be starting to change. In this episode of Beyond the Stars, Host Shannon Kirwin and Morningstar's Michael Born explore the growing global market for faith-based funds, examining how investment strategies rooted in religious values are constructed and how they differ from traditional ESG approaches.

Drawing on research covering more than 850 funds worldwide, the discussion unpacks the diverse landscape of Sharia, Christian, and Catholic investment products, highlighting the different screening methods, portfolio biases, and philosophies that shape these strategies.

The conversation also tackles practical questions for investors: How consistent are faith-based funds in applying religious principles? Do they sacrifice performance or diversification? And are the higher fees often associated with these products justified? 

The full research, Faith-Based Investing: Global Landscape, dives into:

• A global view of 850+ faith-based funds, covering $169 billion in assets and key growth trends 
• How regional and religious differences bear out in portfolios 
• How screening approaches translate into portfolio tilts and sector biases

Shannon Kirwin: Welcome to Beyond the Stars, a conversation with Morningstar analysts about fund industry trends in Europe and abroad. I'm your host, Shannon Kirwin.

If you had the option to invest in a fund aligned with your religious beliefs, would you choose to? For many people, the answer might be yes, but many are still unaware that these options are even out there. Here in Europe, faith-based investment products are still a fairly niche market. But my guest today thinks that could be changing. He's Michael Born, a manager research analyst in Morningstar's London office, who just finished a deep dive into the world of faith-based funds for his recent paper, Faith-Based Investing: Global Landscape. Michael, welcome to the show.

Michael Born: It's good to be back, Shannon. Yeah, so this is an area I've been doing quite a lot of work on recently. So Morningstar has been tracking Sharia funds for well over a decade, and we've actually just launched tags for broader faith-based products. To coincide with this launch, I've published this paper, as you mentioned, which I guess assesses the universe. So what are the different approaches to constructing a faith-based portfolio, what's the implications for such a portfolio, and where have the flows been going, and so forth.

Kirwin: That's great, and I think a lot of users of Morningstar fund data are going to be quite excited to know that there are now tags identifying whether a fund is targeted towards faith-based investors. But while we're on the topic, can you start by explaining how you, or maybe broadly we here at Morningstar, define faith-based investment strategies? And what are the similarities to something like sustainable or ESG investing, and what are the differences?

Born: Yeah, so it's a fundamentally different logic, I suppose. So ESG, that's environmental, social, and governance investing, is really all about optimizing for risk and return, but subject to constraints. So you're minimizing your exposure to environmentally or socially harmful industries or activities that pose a risk to your returns. So when we look at faith-based investing on the other hand, it's rules-based but very much doctrinal. So, you know, a rule against interest-bearing debt or against contraceptive manufacturing, it's generally implemented as a hard exclusionary rule based on a text or a tradition as opposed to being kind of optimized away as in the context of a diversified portfolio. Now, it should be said that many faith-based investors do indeed incorporate ESG factors and they would regard themselves as ethical investors more broadly, but our research firmly showed that implementation varies considerably across the universe and even within a faith. You know, there's really a massive divergence in exclusions at the fund level.

Kirwin: I think that last point might come up a lot today. But before we get there, how did you go about building a clean picture of this universe? Seems like quite the mammoth data task you had before you.

Born: Yeah, so as I said, we added these Christian and Jewish tags in the US market this year. Now, that's a market where all the fund prospectuses are in English, but when we are looking at expanding this into European markets, we see a lot of the universe here, particularly the Christian universes in continental Europe. So, you're seeing prospectuses in German, Spanish, Italian, Portuguese, etc. So, what we did is we used a a large language model as a text classifier, which can map the fund descriptions which we see in these prospectuses into a religious taxonomy. And then because it's such a small universe, we can then manually check the output. So, it resulted in, the global universe, I should say for this study, it was about 850 funds. About 650 of those were Sharia and then about 100 a piece for Christian and Catholic.

Kirwin: And you mentioned seeing some diversity of approaches in terms of the exclusions that you saw, but generally speaking, do faith-based investment funds tend to follow a similar general investment process or was there a range of approaches there as well?

Born: Yeah, there's definitely no single rule book. So, the most common approach that we see is is what you might call negative screening. So, that's just straightforward exclusion and you know, sectors or industries rather like alcohol, gambling, adult entertainment, they kind of show up as exclusions across nearly every tradition. Then you have, I suppose, more religion specific layers. So, pork and alcohol production for Sharia funds, and then abortion and stem cell research for Christian and Catholic funds. So, of the 702 funds where we have that exclusions data, about 500 were just pure negative screening, and overwhelmingly Sharia. But, as I said, Sharia make up by far the most of the universe.

Kirwin: And where did you tend to see more positive screening approaches?

Born: Yeah, so in quite a lot of the Christian funds, so that's I guess the remainder of of the universe, we saw positive or best-in-class screening, so actively selecting for good conduct in about 20 of these 700 or so funds. And then, there's the kind of values-based thematic type approach, so where we're optimizing within a portfolio for this, but it's just not having such rigid thresholds. It's just a qualitative judgment pool about where a certain holding sits with a a religion's principles, and that was about 180 funds, of which they were all Christian.

Kirwin: So, Christian investing as a category is where you tend to see a little bit more interpretive approach, or maybe less rules-based than Sharia investing.

Born: Yes, I definitely think there's more room for interpretation at a product level for Christian and Catholic funds. Some of that can be explained by the market, but I think the biggest thing we have to point to is the actual branches themselves. So, you know, for instance, if you're looking at the Christian Protestant fund market, individual churches have their own interpretations of many of these issues at a church level, and there's just kind of little in the way of historic standardization, where most of these assets were historically managed in segregated accounts and mandates at an institutional level. So, lack of standardization is one of the key points for me that faith-based investors need to look very carefully at the constraints that underlie the strategy, and how this aligns their values, and what it means for their portfolio.

Kirwin: Can you give some examples?

Born: Yeah, of course. So, when we look at gambling, we see about 90% of the non-denominational Christians. That's the Protestant funds, about the same as Sharia, but just 40% of Catholic funds had exclusions thereof. For alcohol, it was about 90% of Christian and Sharia funds, but then just 20% of Catholic funds. And I think more interestingly than that is that we see a considerable geographic divergence even within a branch of a faith.

So, for instance, when when we look at the percentage of Catholic funds which exclude military contracting, it was just 8% in US Catholic funds, but about half of European Catholic funds. And then we look at the European Protestant segment is about 50% exclusions, so similar to the Catholic, but then just 24% in the US. And similar stories for other aspects of weapons like controversial weapons and small arms.

Kirwin: So, where do you think this divergence is coming from?

Born: Yeah, so that lack of standardization and the history led to quite varied interpretation. We see this in the sector exposure, too. So, US domiciled Christian funds tend to be overweight energy. And part of this is because the funds themselves in the US are much more what you call values-led screening rather than sustainability-led. So, oil and gas isn't really excluded unless it violates a specific moral screen. And in the European space, you're seeing a much stronger ESG culture, which layers climate exclusions on top of religious ones and then therefore they're meaningfully underweight energy. So, yeah, there's differences in political and climate and investor appetites. They no doubt play a significant role in in the divergence between products.

Kirwin: So, these are also broader cultural differences, or at least differing institutional norms playing a role, as well. 

Kirwin: What about some of the differences that you notice between Islamic and Christian funds in terms of their portfolio construction?

Born: Yeah, it's something to think about since we've actually seen these biases result in meaningful performance divergences. So, Sharia funds are just structurally underweight financials. Part of Sharia is to prohibit revenue from interest, which basically cuts out most of the conventional banking, but also as a result, are significantly overweight technology. Not that this is I guess a deliberate bet on tech, but when you strip out financials and the highly leveraged and capital intensive businesses, which also violate the Sharia, so, the likes of airlines, utilities. And when we consider where market cap is geared towards in a market like global large-cap equities, it's disproportionately gearing towards technology.

Kirwin: Which I imagine would have been quite the tailwind for Sharia funds over the last few years.

Born: Definitely. It's been enormously profitable over the last decade and actually you've seen Sharia funds on average outperform their non-religious peers in a category like global equities.

Kirwin: Were there any similar sector biases that you saw when you looked at Christian strategies?

Born: Yeah, so healthcare is probably the most consensus. As I mentioned, abortion-related products, but also contraceptives and embryonic stem cell research. But by excluding these sorts of themes, you're just knocking out a real chunk of the investable healthcare universe. Though I would say this is not uniform. So, some funds do retain healthcare exposure either through more nuanced revenue-based threshold screening rather than just blanket exclusion.

Kirwin: So, a practical takeaway here is don't just go by the label, read the prospectus.

Born: Oh, definitely.

Kirwin: So, why is it that you think the Christian fund market is so segmented in the first place? I guess we haven't really seen the same kind of consolidation around a shared standard the way that we've seen for Sharia funds.

Born: Yeah, partly it's a standardization story and Islamic finance got there first by a long way. So, the Bahrain-based AAOIFI set Sharia standards back in 1990 and then Malaysia followed up with its own regulatory blueprint. As a result, you had these standardized rules-based Sharia indices by major index providers since the '90s and this gave the asset managers a template which they could then benchmark against rather than a more bespoke screening build out from scratch. And that's a massive reduction in the barrier to entry. Meanwhile, for the Christian and Catholic faith, you didn't really see that index framework get built out until the 2010s.

Kirwin: Okay, so Islamic investing frameworks had about a two-decade head start on Christian or Catholic frameworks.

Born: Indeed. Although, on the Catholic side, we have actually seen a major development recently. So historically, the task of issuing guidance for investing and really anything to do with investing matters was really left up to the individual dioceses. So, it was just predictably inconsistent results. And then in 2022, the Vatican published Mensuram Bonam, which is something like a formalized Catholic investing doctrine, which could be standardized throughout the industry. So, this centers on on themes like human dignity, ecology, and the common good, as well as favoring prudential judgment over more rigid numerical thresholds. And yes, it's a very different philosophy from Sharia's clean mechanical rule sets, and this shows up in the products there.

Kirwin: That's interesting. Have you actually seen a measurable impact from the launch of this framework in terms of, maybe the pace of fund launches for Catholic investors?

Born: Well, not really yet. And in fact, the number of Catholic launches has actually been lower in the years following Mensuram Bonam than after it. Not that I would say that is causally related. So, what the Vatican has done here is thinking longer term, and I think structurally, quite positive for the industry. So, aiming to create a lot greater consistency. And I think showing a willingness to wade in on investment matters and bring Catholic investors together. So, as we talked about earlier, there's really considerable variation in what is a Catholic investment, and there's very different interpretations. So, having one consolidated framework that institutional investors can reference to, that will really be very helpful, I think.

Kirwin: Beyond the question of whether there are frameworks, I think another big question is also how much demand there really is for these products. I mean, just because someone identifies as Catholic doesn't necessarily mean they feel compelled to invest only in Catholic funds, right?

Born: Yeah, that is right. It's a very astute point, actually, and something that we really should consider when we want to understand the true addressable market. So, whilst the lack of standardization and segmented history are definitely inhibiting factors, I think many people and even institutions of faith are just happy to invest without following such guidance. And then, let's say, inhibit Catholic values in their day-to-day life. By comparison, you know, we see estimates of Islamic finance, the total size being estimated around $4 trillion globally. But this is really supported by institutions who are mandated to invest in a Sharia by institutions who are mandated to invest in Sharia-compliant investments. So, we just don't see that same degree of mandated demand within Christian investing sphere. However, I would say there is definitely going to be a considerable subset of people and institutions of faith who would like to invest in this manner.

I think another challenge here is really on the awareness and availability side. So, I think many people of faith simply don't know that these products exist and that you can invest in this manner. And even if they are aware, I think access can be extremely limited depending on what jurisdiction they live and what investment platforms they can access. And then finally, the really limited product set is an issue. So, you don't really have too many options beyond generalist diversified equity and fixed income strategies. So, I think there's really a lot of room to grow here.

Kirwin: Speaking of which, what does the faith-based fund universe look like today overall in terms of scale and growth?

Born: It's growing, but unevenly. AUM has compounded at about 18% annually over the last 30 years. So, this actually outpaces growth in non-religious global large-cap equity strategies. Sharia definitely dominates. So, you've seen this market grow to over 600 active strategies, which is more than triple the Christian universe. Although, I should say it's had a lot of closures and there's still a lot of very small products. Geographically, Christian and Catholic assets are still overwhelmingly American, about 88% of AUM, whereas Sharia capital has got more of a foothold in the Middle East and Asia.

Kirwin: And what about the split between active and passive?

Born: So the active managers still lead in terms of overall AUM split. So, you know, GuideStone, Catholic Responsible Investments, Eventide, these US-based Christian and Catholic-focused firms, but the passive side, as I've mentioned, is where we've seen most of the growth over recent years. So, the market share has actually quintupled, but the passive side is where we've really seen the most growth over recent years. We've seen market share here quintupling since 2014, albeit from a low base and still well behind what we see in the broader market where passives have basically taken over conventional large-cap investing, but still, being the growth engine there, as you've seen in the more conventional investing space. We have actually seen some of these larger active names being well represented. So, GuideStone, Catholic Responsible Investments are amongst the largest passive managers, but as I said, Sharia has been growing fast, so you're starting to see Sharia-focused parents like HSBC and SP funds to build substantial market share. 

Kirwin: What about costs? How much more am I likely to have to pay to own a faith-based fund rather than an equivalent conventional one?

Born: So, on average, faith-based funds are more expensive than their conventional counterparts. For instance, your average Catholic equity fund charges just over 1% versus about 84 basis points for a non-religious peer. This is a meaningful gap, but there are exceptions. So, you do see some very competitively priced Sharia equity funds in Europe and the US, which is also skewed by those more expensive jurisdictions in in Asia and the Middle East.

I think, though, the passive space is where it's really hardest to justify. Faith-based passive products charge, on average, on an asset-weighted basis, I should say, about double what conventional passives charge.

Kirwin: That is indeed, I imagine, a hard thing to explain to an investor. I mean, is there actually any argument that it's significantly more work to manage a passive faith-based fund versus a conventional passive ETF?

Born: Yeah, there's not really a complexity premium here. Passive Sharia and Christian products, they're not meaningfully harder to construct than conventional ones. Yeah, I should say that there are some quite competitively priced passive products in the active fixed income space. So, I think what you're seeing here is just a smaller market size, smaller funds in general, inhibiting economies of scale and I think less competition specifically is, you know, the likes of Vanguard and BlackRock via iShares, these big players and I think if we start to see some of these large passive players enter into the the market, I think it just will start to compete those funds down quite aggressively. So, yeah, there there are some very competitively priced ETFs and as the universe grows, I would expect them to proliferate and grow assets quicker than the more expensive passes.

Kirwin: So, some positive developments there. Meanwhile, we talked about how some of these sector tilts that are inherent in faith-based funds have impacted returns. What do you think the big picture is? Over the long term, do you think that these investment strategies are meaningfully handicapped compared to conventional funds because of the restrictions that they apply?

Born: Yeah, so it depends in part what level you're really looking at. At the index level, barely any at all. The FTSE All-World Sharia, it runs about a 98% correlation with the FTSE All-World Index, it's actually outperformed due to that tech bias. When you look at the S&P Catholic Values Index, again, it's about 99% correlated with its parents over 15 years. So, it's underperformed over that period largely on the healthcare underweight, but it's basically small numbers either way. 

However, when we actually look at the fund level, if they've tended to underperform, the faith-based funds have tended to underperform non-religious peers by roughly 1% on average, with Christian funds driving most of that gap. But, I would highlight that sector positioning in the active funds has played a notable role here. That divergence between Europe and US where most of the AUM is, those US funds have been much more value-leaning over that post 2010 bit. And we also see some real notable divergences when we look a bit more granularly. So, for instance, from 2009 to 2016, the Europe global large blend peer groups saw outperformance of the non-religious cohort in more than half of those years.

Kirwin: Interesting. So, if someone is listening to this podcast and thinking they might actually be seriously considering investing in a faith-based strategy, what would you say the main things are they should take away from this conversation?

Born: Yeah, so a few things. Firstly, just never assume that a label implies something just by its faith. Go and read the prospectuses. And then I think considering how screening interacts with sector tilts, thinking about what biases might be put into your portfolio. And then I think most importantly is look at the fees, and I think particularly on passive products and compare to non-religious products because you're looking at doubled fee on a mechanically tracked index is very hard to justify in a diversified equity category.

Kirwin: Great. I think that's a great place to leave it. Michael, thank you so much for stopping by, for giving us an introduction to faith-based investment funds, and sharing your research with us. Thanks as always for listening. I'm Shannon Kirwin and this has been Beyond the Stars.